ITEM 1. BUSINESS
Overview
We seek to provide a significant return for our shareholders by acquiring and managing a portfolio of companies, products, royalty agreements and debt facilities in the biotech, pharmaceutical and medical device industries. In 2012, we began providing alternative sources of capital through royalty monetizations and debt facilities, and in 2016, we began acquiring commercial-stage products and launching specialized companies dedicated to the commercialization of these products. To date, we have consummated 16 of such transactions. Of these transactions, five have concluded with an average annual internal rate of return of 18.4%: Merus Labs International, Inc., Durata Therapeutics, Inc., AxoGen, Inc., Avinger, Inc. and Paradigm Spine, LLC. We have four debt transactions outstanding, representing deployed and committed capital of
$269.0 million
and
$309.0 million
, respectively: CareView Communications, Inc., kaléo, Inc., Direct Flow Medical, Inc. and LENSAR, Inc.; we have one hybrid royalty/debt transaction outstanding, representing deployed and committed capital of
$44.0 million
: Wellstat Diagnostics, LLC; and we have six royalty transactions outstanding, representing deployed and committed capital of
$496.1 million
and
$537.1 million
, respectively: KYBELLA
®
, AcelRx Pharmaceuticals, Inc., ARIAD Pharmaceuticals, Inc., The Regents of the University of Michigan, Viscogliosi Brothers, LLC and Depomed, Inc.. Our equity and loan investments in Noden Pharma DAC and Noden Pharma USA, Inc. (together “Noden”) represents deployed and committed capital of
$110.0 million
and
$202.0 million
, respectively.
In connection with our acquisition of Tekturna through Noden, described in more detail below under the heading “Product Sales-Noden Purchase Agreement,” in July 2016, we began operating in two reportable segments: income generating assets and product sales. Our income generating assets segment consists of royalties from issued patents in the United States and elsewhere, covering the humanization of antibodies, which we refer to as the Queen et al. patents; notes and other long-term receivables, royalty rights - at fair value and equity investments. Our product sales segment consists of revenue derived from Tekturna
®
, Tekturna HCT
®
, Rasilez
®
and Rasilez HCT
®
(collectively, the “Noden Products” or “Tekturna”) sales. Prospectively, we expect to focus on the acquisition of additional products and expect to transact fewer royalty transactions and still fewer debt transactions. We anticipate that over time more of our revenues will come from our product sales segment and less of our revenues will come from our income generating assets segment.
Financial information about our operations, including our revenues and net income for the years ended
December 31, 2016
,
2015
and
2014
, and our total assets as of
December 31, 2016
and
2015
, is included in our consolidated financial statements and accompanying notes in Item 8, “Financial Statements and Supplementary Data.”
Product Sales
We recently began acquiring, and plan to continue to acquire, commercial-stage products and companies who own or are acquiring pharmaceutical products. Our investment objective with respect to these transactions is to maximize our portfolio’s total return by generating current income from product sales. We consummated our first investment of this type with Tekturna in July 2016.
Noden Purchase Agreement
On July 1, 2016, Noden Pharma DAC, entered into an asset purchase agreement (“Noden Purchase Agreement”) where by it purchased from Novartis Pharma AG (“Novartis”) the exclusive worldwide rights to manufacture, market, and sell the branded prescription medicine product sold under the name Tekturna
®
and Tekturna HCT
®
in the United States and Rasilez
®
and Rasilez HCT
®
in the rest of the world (collectively the “Noden Products”) and certain related assets and assumed certain related liabilities (the “Noden Transaction”). Upon the consummation of the Noden Transaction, a noncontrolling interest holder acquired 6% equity interest in Noden. The equity interest of the noncontrolling interest holder is subject to vesting and repurchase rights over a four-year period. At December 31, 2016, 80% of the noncontrolling interest was subject to repurchase. We determined that Noden shall be consolidated under the voting interest model as of
December 31, 2016
.
Tekturna (or Rasilez outside the United States) contains aliskiren, a direct renin inhibitor, for the treatment of hypertension. While indicated as a first line treatment, it is more commonly used as a third line treatment in those patients who are intolerant of angiotensin converting enzyme inhibitors (“ACEs”) and angiotensin II receptor blockers (“ARBs”). It is not indicated for use with ACEs and ARBs in patients with diabetes or renal impairment. Tekturna HCT (or Rasilez HCT outside the United States) is a combination of aliskiren and hydrochlorothiazide, a diuretic, for the treatment of hypertension in patients not adequately controlled by monotherapy and as an initial therapy in patients likely to need multiple drugs to achieve their blood pressure goals. It is not indicated for use with ACEs and ARBs in patient with diabetes or renal impairment and not for use in patients with known anuria or hypersensitivity to sulfonamide derived drugs. Studies indicate that approximately 12% of hypertension patients are ACE/ARB inhibitor-intolerant. Tekturna and Tekturna HCT are contraindicated for use by pregnant women.
The agreement between Novartis and Noden provides for various transition periods for development and commercialization activities relating to the Noden Products. Initially, Novartis will continue to distribute the four products on behalf of Noden worldwide and Noden will receive a profit split on such sales. In the United States, the duration of the profit split ran from July 1, 2016 through October 4, 2016. Outside the United States, the profit split is expected to run from July 1, 2016 through approximately March 31, 2017. The event that terminates the profit split arrangement is the transfer of the marketing authorization for the four products from Novartis to Noden. Generally, the profit split to Noden is defined as gross revenues less product cost, a low single digit percentage as a fee to Novartis and the applicable rebates, trade discounts, returns, etc. Prior to the transfer of the marketing authorization, revenue will be recognized on a “net” basis; after the transfer of the marketing authorization, revenue will be recognized on a “gross” basis.
Because Novartis has not actively commercialized the four products for a number of years, and sales of the four products have been declining annually since that time, the ability of Noden to promote these four products successfully and efficiently will determine whether revenues can be stabilized and grown.
Income Generating Assets
We acquire income generating assets when such assets can be acquired on terms that we believe allow us to increase return to our stockholders. These income generating assets are typically in the form of notes receivables, royalty rights and hybrid notes/royalties receivable and in some cases, equity. We primarily focus our income generating asset acquisition strategy on commercial-stage therapies and medical devices having strong economic fundamentals. However, we do not expect that our acquired income generating assets will, in the near term, replace completely the revenues we generated from our license agreements related to our Queen et al. patents. In the second quarter of 2016, our revenues materially decreased after we stopped receiving payments from certain Queen et al. patent licenses and legal settlements, which accounted for 68%, 82% and 83% of our 2016, 2015 and 2014 revenues.
Royalties from Queen et al. patents
While the Queen et al. patents have expired and the resulting royalty revenue has dropped substantially since the first quarter of 2016, we continue to receive royalty revenue from one product under the Queen et al. patent licenses, Tysabri
®
, as a result of sales of licensed product that was manufactured prior to patent expiry.
Notes and Other Long-Term Receivables
We have entered, and may continue to enter, into credit agreements with borrowers across the healthcare industry, under which we make available cash loans to be used by the borrower. Obligations under these credit agreements are typically secured by a pledge of substantially all of the assets of the borrower and any of its subsidiaries. While we currently maintain this portfolio of notes receivable, our intention is to pursue fewer debt transactions, and focus on acquiring additional specialty pharmaceutical products or companies.
At December 31, 2016, we had a total of five notes receivable transactions outstanding and one note/royalty (hybrid) receivable transaction outstanding. The most significant investments are summarized below:
CareView
Deal Summary
In July 2015, we entered into a credit agreement with CareView Communications Inc. (“CareView”), under which we made available to CareView up to $40.0 million in two tranches of $20.0 million each. Under the terms of the credit agreement each tranche has a five-year maturity and outstanding borrowings under the credit agreement will bear interest at the rate of 13.5% per annum and are payable quarterly in arrears. Principal repayment will commence on the ninth quarterly interest payment date of each tranche of loans. The principal amount outstanding at commencement of repayment will be repaid in equal installments until final maturity of the loans. In addition, we have a security interest in substantially all of CareView’s assets.
In October 2015, we funded the first tranche of $20.0 million, net of fees. The additional $20.0 million in the form of a second tranche continues to be available upon CareView’s attainment of specified milestones relating to the placement of CareView Systems and Consolidated EBITDA (as defined in the credit agreement), to be accomplished no later than June 30, 2017.
Technology
CareView is a provider of products and on-demand application services for the healthcare industry by specializing in bedside video monitoring, archiving and patient care documentation systems and patient entertainment services.
kaléo
Deal Summary
In April 2014, we entered into a note purchase agreement with Accel 300 LLC (“Accel 300”), a wholly-owned subsidiary of kaléo, Inc. (“kaléo”), pursuant to which we acquired $150.0 million of secured notes due 2029. The secured notes were issued pursuant to an indenture between Accel 300 and U.S. Bank, National Association, as trustee, and are secured by 20% of net sales of its first approved product, Auvi-Q
®
(epinephrine auto-injection, USP) (known as Allerject™ in Canada), and 10% of net sales of kaléo’s second proprietary auto-injector based product, EVZIO (naloxone hydrochloride injection), and a pledge of kaléo’s equity ownership in Accel 300. The notes carry interest at 13% per annum, paid quarterly in arrears on principal outstanding. kaléo may redeem the notes at any time, subject to a redemption premium.
In March 2016, sanofi-aventis U.S. LLC (“Sanofi US”) and kaléo terminated their license and development agreement. All U.S. and Canadian commercial and manufacturing rights to Auvi-Q and Allerject™ were returned to kaléo. On February 14, 2017, kaléo reintroduced Auvi-Q to the U.S. market.
As of December 31, 2016, kaléo had a principal balance of $144.8 million due to us. kaléo continued to make interest payments due to us under the note purchase agreement while Auvi-Q was not marketed.
Technology
Auvi-Q is used to treat life-threatening allergic reactions (anaphylaxis) in people who are at risk for or have a history of these reactions.
EVZIO is approved for the emergency treatment of known or suspected opioid overdose, as manifested by respiratory and/or central nervous system depression.
Direct Flow Medical
Deal Summary
In November 2013, we entered into a credit agreement with Direct Flow Medical, Inc. (“Direct Flow Medical”) under which we agreed to provide up to $50.0 million to Direct Flow Medical, to be used to refinance its existing credit facility and fund the commercialization of its transcatheter aortic valve system used to treat aortic stenosis. An initial $35.0 million was funded at the close of the transaction, with the remaining $15.0 million to be funded upon the achievement of a specified milestone. We funded the $15.0 million second tranche to Direct Flow Medical, net of fees in November 2014. Outstanding borrowings under the first tranche bore interest at the rate of 15.5% per annum, payable quarterly in arrears. Upon occurrence of the borrowing of this second tranche, the interest rate applicable to all loans under the credit agreement was decreased to 13.5% per annum, payable quarterly in arrears.
The obligations under the credit agreement are secured by a pledge of substantially all of the assets of Direct Flow Medical and any of its subsidiaries.
In January 2016, we funded an additional $5.0 million to Direct Flow Medical in the form of a short-term secured promissory note that was converted into a loan under the credit agreement with substantially the same interest and payment terms as the existing loans. Subsequently in July, September and November 2016, we advanced additional loans of $1.5 million, $1.5 million, and $1.0 million respectively, as Direct Flow Medical sought to obtain an equity financing. On November 16, 2016, Direct Flow Medical advised us that its potential financing source had modified its proposal from an equity investment to a loan with a substantially smaller amount and under less favorable terms. Direct Flow Medical shut down its operations in December 2016 and in January 2017 made an assignment for the benefit of creditors. We then initiated foreclosure proceedings, which have since concluded, resulting in our obtaining ownership of most of the Direct Flow Medical assets through our wholly-owned subsidiary, DFM, LLC.
In January 2017, we and DFM, LLC entered into an Intellectual Property Assignment Agreement with Hong Kong Haisco Pharmaceutical Co., Limited (“Haisco”), a Chinese pharmaceutical company, whereby Haisco acquired former Direct Flow Medical clinical, regulatory and commercial information and intellectual property rights exclusively in China for $7.0 million.
Technology
Direct Flow Medical developed transcatheter heart technologies, including its Transcatheter Aortic Valve System that is designed to treat aortic stenosis. It was also developing a similar system for stenotic mitral valves. Direct Flow Medical has shut down its operations.
LENSAR
Deal Summary
In October 2013, we entered into a credit agreement with LENSAR, Inc. (“LENSAR”) under which we made available to LENSAR up to $60.0 million to be used by LENSAR in connection with the commercialization of its currently marketed LENSAR™ Laser System. Of the $60.0 million available to LENSAR, an initial $40.0 million was funded by us at the close of the transaction. The remaining $20.0 million in the form of a second tranche is no longer available to LENSAR under the terms of the credit agreement. Outstanding borrowings under the loans bore interest at the rate of 15.5% per annum, payable quarterly in arrears. The obligations under the credit agreement are secured by a pledge of substantially all of the assets of LENSAR.
In May 2015, we entered into a forbearance agreement with LENSAR as a result of LENSAR’s failure to comply with a liquidity covenant and make interest payments due under the credit agreement. Between May and December 2015, we provided additional funding to LENSAR.
In December 2015, LENSAR, LLC (“LENSAR/Alphaeon”), a wholly owned subsidiary of Alphaeon Corporation (“Alphaeon”), acquired certain assets of LENSAR and assumed $42.0 million in loans as part of the borrowings under our prior credit agreement with LENSAR. In addition, Alphaeon issued 1.7 million shares of its Class A common stock to us.
In December 2016, LENSAR, re-acquired the assets from Alphaeon and we entered into an amended and restated credit agreement with LENSAR whereby LENSAR assumed all obligations outstanding under the credit agreement with LENSAR/Alphaeon. Also in December 2016, LENSAR filed, with our support, a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code (“Chapter 11 case”). In January 2017, we agreed to provide debtor-in-possession financing of up to $2.8 million to LENSAR so that it can continue to operate its business during the remainder of the Chapter 11 case. LENSAR has filed a Chapter 11 plan of reorganization with our support under which, subject to bankruptcy court approval, it is expected that LENSAR will issue equity securities to us in exchange for a portion of our claims in the Chapter 11 case and will become one of our operating subsidiaries. We estimate that the bankruptcy proceeding will be concluded in the second quarter of 2017.
Technology
The LENSAR Laser System is approved by the U.S. Food and Drug Administration (the “FDA”) to perform both corneal and arcuate incisions, as well as lens fragmentation and anterior capsulotomy (with or without phacofragmentation), during cataract surgery.
Wellstat
Deal Summary
In March 2012, we executed a $7.5 million two-year senior secured note receivable with the holders of the equity interests in Wellstat Diagnostics, LLC a/k/a Defined Diagnostics, LLC (“Wellstat Diagnostics”). In August 2012, we and Wellstat Diagnostics amended the note receivable, providing a senior secured note receivable of $10.0 million, bearing interest at 12% per annum, to replace the original $7.5 million note receivable. This $10.0 million note receivable was repaid on November 2, 2012, using the proceeds of the $40.0 million credit facility we entered into on the same date.
In November 2012, we entered into a $40.0 million credit agreement with Wellstat Diagnostics pursuant to which we were to accrue quarterly interest payments at the rate of 5% per annum. In January 2013, Wellstat Diagnostics defaulted on the credit agreement, and as a result both parties agreed to enter into a forbearance agreement whereby we agreed to provide additional funding. In August 2013, we entered into an amended and restated credit agreement with terms substantially the same as those of the original credit agreement. However, pursuant to the amended and restated credit agreement: (i) the principal amount was reset to approximately $44.1 million.
During 2015 and 2016 we, Wellstat Diagnostics, and Samuel J. Wohlstadter, Nadine H. Wohlstadter, Duck Farm, Inc., Hebron Valley Farms, Inc., HVF, Inc., Hyperion Catalysis EU Limited, Hyperion, NHW, LLC, Wellstat AVT Investment, LLC, Wellstat Biocatalysis, LLC, Wellstat Biologics Corporation, Wellstat Diagnostics, Wellstat Immunotherapeutics, LLC, Wellstat Management Company, LLC, Wellstat Ophthalmics Corporation, Wellstat Therapeutics Corporation, Wellstat Therapeutics EU Limited, Wellstat Vaccines, LLC and SJW Properties, Inc., the guarantors of Wellstat Diagnostics’ obligations to us (collectively, the “Wellstat Diagnostics Guarantors”) were involved in a series of legal actions. A further discussion of the Wellstat litigation is included in Note 22, “Legal Proceedings” in Item 8, “Financial Statements and Supplementary Data” of this Annual Report.
Technology
Wellstat Diagnostics is a private company dedicated to the development, manufacture, sale and distribution of small point of care diagnostic systems that can perform a wide variety of tests targeting the clinical diagnostics market.
Royalty Rights - At Fair Value
We have entered into various royalty purchase agreements with counterparties, whereby the counterparty conveys to us the right to receive royalties that are typically payable on sales revenue generated by the sale, distribution or other use of the counterparties’ products. Certain of our royalty agreements provide the counterparty with the right to repurchase the royalty rights at any time for a specified amount.
We record the royalty rights at fair value using discounted cash flows related to the expected future cash flows to be received. We use significant judgment in determining our valuation inputs, including estimates as to the probability and timing of future sales of the licensed product. A third-party expert is generally engaged to assist us with the development of our estimate of the expected future cash flows. The estimated fair value of the asset is subject to variation should those cash flows vary significantly from our estimates. At each reporting period, an evaluation is performed to assess those estimates, discount rates utilized and general market conditions affecting fair market value.
While we currently maintain this portfolio of royalty rights, our intention is to pursue fewer of these transactions while we focus on acquiring additional specialty pharmaceutical products or companies.
At
December 31, 2016
, we had a total of six royalty rights transactions outstanding, which are summarized below:
KYBELLA
Deal Summary
In July 2016, we entered into a royalty purchase and sales agreement with an individual, whereby we acquired the individual’s rights to receive certain royalties on sales of KYBELLA by Allergan, Plc in exchange for a $9.5 million cash payment and up to $1.0 million in future milestone payments based upon achieving specified product sales targets. We started to receive royalty payments during the third quarter of 2016.
Technology
KYBELLA is an FDA approved injectable treatment for adults with moderate-to-severe fat below the chin, known as submental fat. KYBELLA contains deoxycholic acid which destroys fat cells, and
allows for a safer and less invasive alternative to surgical procedures
.
AcelRx
Deal Summary
In September 2015, we entered into a royalty interest assignment agreement (the “AcelRx Royalty Agreement”) with ARPI LLC, a wholly owned subsidiary of AcelRx Pharmaceuticals, Inc. (“AcelRx”), whereby we acquired a portion of the royalties on expected sales of Zalviso™ (sufentanil sublingual tablet system) in the European Union, Switzerland and Australia by AcelRx’s commercial partner, Grünenthal. Under the terms of the agreement, we paid AcelRx $65.0 million, and in exchange, we will receive 75% of the royalties AcelRx receives from Grünenthal as well as 80% of the first four commercial milestone payments, until the earlier of occur of (i) receipt by us of payments equal to three times the cash payments made to AcelRx and (ii) the expiration of the licensed patents. We believe that the applicable patents run until January 2032. Zalviso received marketing approval by the European Commission in September 2015. Grünenthal launched Zalviso in the second quarter of 2016 and we started to receive royalties in the third quarter of 2016.
Technology
Zalviso is a combination drug and device product which, using a patient controlled dispenser, delivers a sub-lingual formulation of sufentanil, an opioid with a high therapeutic index. Zalviso is approved in the European Union.
ARIAD
Deal Summary
In July 2015, we entered into the revenue interest assignment agreement (the “ARIAD Royalty Agreement”) with ARIAD Pharmaceuticals, Inc. (“ARIAD”), whereby we agreed to provide ARIAD with up to $200.0 million in revenue interest financing in exchange for royalties based on the net revenues of Iclusig
®
(ponatinib). The purchase price of $100.0 million was payable in two tranches of $50.0 million each, with the first tranche having been funded on July 28, 2015 and the second tranche having been funded on July 28, 2016. Prior to the amendment as discussed below. ARIAD had an option to draw up to an additional $100.0 million at any time between the sixth and twelfth month anniversaries of the closing date.
Under the terms of the ARIAD Royalty Agreement, we initially received 2.5% of the worldwide net revenues of Iclusig until the one-year anniversary of the closing date, at which time the royalty increased to 5.0% of the worldwide net revenues of Iclusig and remains until December 31, 2018. Beginning January 1, 2019 and thereafter, the royalty rate will increase to 6.5%, subject to an additional increase to 7.5% if our funding exceeds $150 million. If we do not receive payments equal to or greater than the total amount funded on or before the fifth anniversary of each of the respective funding dates, ARIAD will pay us the difference between the amounts funded by us and the amounts paid to such date. In the event of certain shortfall, we may also receive royalties on brigatinib, a product for which ARIAD has filed for approval in the United States and European Unions.
In May 2016, ARIAD entered into a share purchase agreement with Incyte Corporation (“Incyte”), pursuant to which ARIAD sold to Incyte all of the outstanding shares of ARIAD Pharmaceuticals (Luxembourg) S.a.r.l., which is the parent company of ARIAD’s European subsidiaries responsible for the commercialization of Iclusig in the European Union and certain other countries.
In May 2016, we and ARIAD amended the ARIAD Royalty Agreement to, among other things, include the net sales of Iclusig made by Incyte Corporation in the amount payable to us after its acquisition of ARIAD’s commercialization operations with respect to Iclusig in the European Union and certain other countries. In addition, we agreed to restructure future funding under the ARIAD Royalty Agreement such that ARIAD’s option to draw up to an additional $100.0 million between January and July of 2016 was reduced to a maximum amount of up to an additional $40.0 million, which would be funded at ARIAD’s option in July of 2017. The amendment to the ARIAD Royalty Agreement did not affect our obligation to fund the second tranche of $50.0 million on the first anniversary of the ARIAD Royalty Agreement, which was funded in July 2016.
We have a put option based upon certain events, including a change of control at ARIAD, and ARIAD has a call option to repurchase the revenue interest at any time. Both the put and call prices have been pre-determined. In January 2017, Takeda Pharmaceutical Company Limited (“Takeda”) announced that it had entered into a definitive agreement to acquire ARIAD. The acquisition was consummated on February, 16, 2017 and we exercised our put option on the same day, which will result in a payment to us of a 1.2x multiple of the $100.0 million funded by us under the ARIAD Royalty Agreement, less royalty payments already received by us. We have received $9.3 million of royalty payments through December 31, 2016.
Technology
Iclusig is approved in the United States, European Union, Australia, Israel, Canada and Switzerland. In the United States, Iclusig is a kinase inhibitor indicated for the:
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treatment of adult patients with T315I-positive chronic myeloid leukemia (chronic phase, accelerated phase, or blast phase) or T315I-positive Philadelphia chromosome positive acutelymphoblastic leukemia (Ph+ ALL), and
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treatment of adult patients with chronic phase, accelerated phase, or blast phase chronic myeloid leukemia or Ph+ ALL for whom no other tyrosine kinase inhibitor (TKI) therapy is indicated.
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University of Michigan
Deal Summary
In November 2014, we acquired a portion of the Regents of the University of Michigan’s (“U-M”) worldwide royalty interest in Cerdelga™ (eliglustat) for $65.6 million pursuant to the Royalty Purchase and Sale Agreement with U-M (the “U-M Royalty Agreement”). Under the terms of the U-M Royalty Agreement, we will receive 75% of all royalty payments due under U-M’s license agreement with Genzyme Corporation, a Sanofi company (“Genzyme”) until expiration of the licensed patents, excluding any patent term extension. The royalty rate used to calculate the royalties to be paid by Genzyme to U-M was not disclosed by the parties.
Technology
Cerdelga, an oral therapy for adult patients with Gaucher disease type 1, was developed by Genzyme. Cerdelga was approved in the United States in August 2014, in the European Union in January 2015 and in Japan in March 2015.
Viscogliosi Brothers
Deal Summary
In June 2014, we entered into a Royalty Purchase and Sale Agreement (the “VB Royalty Agreement”) with Viscogliosi Brothers, LLC (“VB”), whereby we acquired the right to receive royalties on net sales of a spinal implant that has received pre-market approval from the FDA held by VB and commercialized by Paradigm Spine, LLC (“Paradigm Spine”) in exchange for a $15.5 million cash payment. The royalty rights acquired includes royalties accruing from and after April 1, 2014. We receive all royalty payments due to VB pursuant to certain technology transfer agreements between VB and Paradigm Spine until we have received payments equal to 2.3 times the cash payment it made to VB, after which all payment rights will be returned to VB. VB may repurchase the royalty right at any time on or before June 26, 2018, for a specified amount. The chief executive officer of Paradigm Spine is one of the owners of VB. The Paradigm Spine Credit Agreement, entered into on February 14, 2014 between us and Paradigm Spine (the “Paradigm Spine Credit Agreement”), and the VB Royalty Agreement were negotiated separately.
Technology
The coflex
®
Interlaminar Technology is an Interlaminar Stabilization
®
device indicated for use in one or two level lumbar stenosis from L1-L5 in skeletally mature patients with at least moderate impairment in function.
Depomed
Deal Summary
In October 2013, we entered into the Royalty Purchase and Sale Agreement (the “Depomed Royalty Agreement”) with Depomed, Inc. (“Depomed”), whereby we acquired the rights to receive royalties and milestones payable on sales of five Type 2 diabetes products licensed by Depomed in exchange for a $240.5 million cash payment.
Under the terms of the Depomed Royalty Agreement, we will receive all royalty and milestone payments due under license agreements between Depomed and its licensees until we have received payments equal to two times the cash payment made to Depomed, after which all net payments received by Depomed will be shared evenly between us and Depomed.
The Depomed Royalty Agreement terminates on the third anniversary following the date upon which the later of the following occurs: (a) October 25, 2021, or (b) at such time as no royalty payments remain payable under any license agreement and each of the license agreements has expired by its terms.
Technology
The rights acquired include Depomed’s royalty and milestone payments accruing from and after October 1, 2013: (a) from Valeant Pharmaceuticals International, Inc. (“Valeant”) with respect to sales of Glumetza
®
(metformin HCL extended-release tablets) in the United States; (b) from Merck & Co., Inc. with respect to sales of Janumet XR
®
(sitagliptin and metformin HCL extended-release); (c) from Janssen Pharmaceuticals N.V. (“Janssen Pharmaceuticals”) with respect to potential development milestones and sales of its fixed-dose combination of Invokana
®
(canagliflozin, a sodium glucose co-transorter 2 (SGLT2) inhibitor) and extended-release metformin tablets, marketed as Invokamet XR
®
; (d) from Boehringer Ingelheim GmbH (“Boehringer Ingelheim”) with respect to potential development milestones and sales of the fixed-dose combinations of drugs and extended-release metformin subject to Depomed’s license agreement with Boehringer Ingelheim including its recently approved products, Jentadueto XR
®
and Synjardy XR
®
; and (e) from LG Life Sciences and Valeant for sales of extended-release metformin in Korea and Canada, respectively. On May 31, 2016, Boehringer Ingelheim and Eli Lilly & Company (“Eli Lilly”) announced that
the FDA approved Jentadueto XR (a fixed dose combination of
Linagliptin, a dipeptidyl peptidase-4 inhibitor and
extended-release metformin tablets)
for the treatment of type 2 diabetes in adults, which will be marketed by both companies. This approval triggered the payment of a milestone to us of $6.0 million.
On September 21, 2016,
Janssen Pharmaceuticals announced that the FDA approved Invokamet XR for the treatment of type 2 diabetes in adults.
This approval triggered the payment of a milestone to us of $5.0 million. On December 12, 2016, Boehringer Ingelheim and Eli Lilly announced that the FDA approved Synjardy
®
XR (a fixed dose combination of
Empagliflozin, a sodium-glucose co-transporter 2 inhibitor,
and
extended-release metformin tablets)
for the treatment of type 2 diabetes in adults, which will be marketed by both companies.
This approval triggered the payment of a milestone to us of $6.0 million. We will also be receiving royalties on the net sales of these three newly approved products.
Equity Investments
In addition to credit and royalty agreements, we make equity investments in healthcare companies. For example, we have acquired warrants to purchase equity interests in connection with certain of our existing notes receivable transactions. Our investment objective with respect to these equity investments is to maximize our portfolio total return by generating current income from capital appreciation. Our primary business objectives are to increase our net income, net operating income and asset value by investing in warrants and equity of companies with the potential for equity appreciation and realized gains.
Intellectual Property
Patents
We have been issued patents in the United States and elsewhere, covering the humanization of antibodies, which we refer to as our Queen et al. patents. Our Queen et al. patents, for which final patent expiry was in December 2014, covered, among other things, humanized antibodies, methods for humanizing antibodies, polynucleotide encoding in humanized antibodies and methods of producing humanized antibodies.
Our U.S. patent No. 5,693,761 (the “761 Patent”), which expired on December 2, 2014, covered methods and materials used in the manufacture of humanized antibodies. In addition to covering methods and materials used in the manufacture of humanized antibodies, coverage under our ‘761 Patent typically extended to the use or sale of compositions made with those methods and/or materials. Our European patent no. 0 451 216B (the “216B Patent”) expired in Europe in December 2009. We have been granted Supplementary Protection Certificates (“SPCs”) for the Avastin
®
, Herceptin
®
, Lucentis
®
, Xolair
®
and Tysabri
®
products in many of the jurisdictions in the European Union in connection with the ‘216B Patent. The SPCs effectively extended our patent protection with respect to Avastin, Herceptin, Lucentis, Xolair and Tysabri generally until December 2014, except that the SPCs for Herceptin expired in July 2014. Because SPCs are granted on a jurisdiction-by-jurisdiction basis, the duration of the extension varies slightly in certain jurisdictions. Our revenue from payments made from the Queen et al. patents license and settlement materially decreased in the second quarter of 2016, with only revenue from Tysabri being recognized after such period.
Tekturna is protected by multiple patents worldwide, which specifically cover the composition of matter, the pharmaceutical formulations and methods of production. In the United States, the FDA Orange Book lists one patent, U.S. patent No. 5,559,111 (the “111 Patent”), which covers compositions of matter comprising aliskiren. The ‘111 Patent expires on July 21, 2018 unless a pediatric extension is granted, in which case it will expire on January 21, 2019. In addition, the FDA Orange Book for Tekturna lists U.S. Patent No. 8,617,595, which covers certain compositions comprising aliskiren, together with other formulation components, and will expire on February 19, 2026. The FDA Orange Book for Tekturna HCT lists U.S. patent No. 8,618,172, which covers certain compositions comprising aliskiren, together with other formulation components, and will expire on July 13, 2028. In Europe, European patent No. 678 503B (the “503B Patent”) expired in 2015. However, numerous SPCs have been granted which are based on the 503B Patent and which will provide for extended protection. These SPCs generally expire in April of 2020.
Licensing Agreements
We have entered into licensing agreements under our Queen et al. patents with numerous entities that are independently developing or have developed humanized antibodies. Although the Queen et al. patents and related rights have expired, we are entitled under our license agreements to continue to receive royalties in certain instances based on net sales of products that were made prior to but sold after patent expiry. In addition, we are entitled to royalties based on know-how provided to a licensee. In general, these agreements cover antibodies targeting antigens specified in the license agreements. Under our licensing agreements, we are entitled to receive a flat-rate royalty based upon our licensees’ net sales of covered antibodies.
Our total revenues from licensees under our Queen et al. patents were
$166.2 million
,
$485.2 million
and
$486.9 million
, net of rebates and foreign exchange hedge adjustments, for the years ended
December 31, 2016
,
2015
and
2014
, respectively.
Licensing Agreements for Marketed Products
In the year ended
December 31, 2016
, we received royalties on sales of the seven humanized antibody products listed below, all of which are currently approved for use by the FDA and other regulatory agencies outside the United States.
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Licensee
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Product Names
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Genentech
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Avastin
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Herceptin
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Xolair
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Lucentis
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Perjeta
®
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Kadcyla
®
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Biogen
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Tysabri
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Genentech
We entered into a master patent license agreement, effective September 25, 1998, under which we granted Genentech, Inc. (“Genentech”) a license under our Queen et al. patents to make, use and sell certain antibody products.
On January 31, 2014, we entered into the Settlement Agreement with Genentech and F. Hoffman LaRoche, Ltd. (“Roche”) (“Settlement Agreement”) that resolved all existing legal disputes between the parties.
The Settlement Agreement precluded Genentech and Roche from challenging the validity of our patents, including our SPCs in Europe, from contesting their obligation to pay royalties to us, from contesting patent coverage for Avastin, Herceptin, Lucentis, Xolair, Perjeta, Kadcyla and Gazyva (collectively, the “Genentech Products”) and from assisting or encouraging any third party in challenging our patents and SPCs. The Settlement Agreement further outlined the conduct of any audits initiated by us of the books and records of Genentech in an effort to ensure a full and fair audit procedure. Finally, the Settlement Agreement clarified that the sales amounts from which the royalties are calculated do not include certain taxes and discounts. Under the terms of the Settlement Agreement, we ceased receiving any revenue from Genentech after the first quarter of 2016.
Biogen
We entered into a patent license agreement, effective April 24, 1998, under which we granted to Elan Corporation, plc (“Elan”) a license under our Queen et al. patents to make, use and sell antibodies that bind to the cellular adhesion molecule α4 in patients with multiple sclerosis. Under the agreement, we are entitled to receive a flat royalty rate in the low, single digits based on Elan’s net sales of the Tysabri product. This license agreement entitles us to royalties following the expiration of our patents with respect to sales of licensed product manufactured prior to patent expiry in jurisdictions providing patent protection. In April 2013, Biogen, Inc. (“Biogen”) completed its purchase of Elan’s interest in Tysabri, and in connection with such purchase all obligations under our patent license agreement with Elan were assumed by Biogen.
Major Customers
Our revenues consist almost entirely of royalties and the changes in fair value of our royalty right assets. In
2016
,
2015
and
2014
, Genentech accounted for
43%
,
70%
, and
71%
of our revenues, respectively, and Biogen accounted for
24%
,
9%
and
10%
of our revenues, respectively. Although the last of our Queen et al. patents expired in December 2014, the royalty payments extended beyond the patent expiration based on the terms of our licenses and our legal settlements. In the second quarter of 2016, our revenues materially decreased after we stopped receiving payments from certain Queen et al. patent licenses and legal settlements, which accounted for 68%, 82% and 83% of our 2016, 2015 and 2014 revenues.
Beginning in the fourth quarter of 2016, we started to generate revenue from product sales to three major wholesalers in the United States. As of December 31, 2016, these three wholesalers accounted for 1.6%, 1.9% and 1.6%, respectively, of our total net sales in fiscal year 2016.
Competition
The two products of Noden are direct renin inhibitors approved for the treatment of hypertension. They compete against a number of classes of treatments including changes in diet, thiazide diuretics, ACEs, ARBs, calcium channel blockers, cardioselective beta blockers, alpha blockers, direct vasodilators and centrally acting agents. With the exception of diet, there are numerous drugs within each of the classes enumerated above, most of which have generic versions that are less expensive than Tekturna and Tekturna HCT. Physicians may also treat hypertension patients by combining one or more of the enumerated classes of treatments. Diet, thiazide diuretics, ACEs, ARBs and calcium channel blockers are most commonly used as first line treatments for hypertension and dominate the market, in part, because of the availability of low cost generics in each category. Renin inhibitors, such as Tekturna and Tekturna HCT which are the only approved direct renin inhibitors, and beta blockers are used thereafter followed by direct vasodilators, central acting agents and alpha blockers. Tekturna and Tekturna HCT are generally perceived as alternatives for patients who do not respond to, or are intolerant of, the first line therapies. In the United States, there are approximately six thiazide diuretics, eleven ACEs, eight ARBs and thirty-five calcium channel blockers, in each case, a number of which have one or more generic versions. There are approximately ten cardioselective beta blockers in the United States, a number of which have one or more generic versions.
Governmental Regulation
The research and development, manufacturing and marketing of pharmaceutical products are subject to regulation by numerous governmental authorities in the United States and other countries. We and our licensees, borrowers and royalty-agreement counterparties, depending on specific activities performed, are subject to these regulations. In the United States, pharmaceuticals are subject to regulation by both federal and various state authorities, including the FDA. The Federal Food, Drug and Cosmetic Act and the Public Health Service Act govern the testing, manufacture, safety, efficacy, labeling, storage, record keeping, approval, advertising and promotion of pharmaceutical products and there are often comparable regulations that apply at the state level. There are similar regulations in other countries as well. For both currently marketed and products in development, failure to comply with applicable regulatory requirements can, among other things, result in delays, the suspension of regulatory approvals, as well as possible civil and criminal sanctions. In addition, changes in existing regulations could have a material adverse effect
on us or our licensees, borrowers or royalty-agreement counterparties. For a discussion of the risks associated with government regulations, see Item 1A, “Risk Factors.”
Manufacturing
We currently contract with one third-party for manufacturing our Noden Products, this arrangement is covered by a foreign long-term supply agreement. To date, our third-party manufacturer has met our manufacturing requirements. Although to date we have not experienced interruptions in supplies, we cannot assure that we will continue to receive uninterrupted or adequate supplies of such products. We expect that the third-party manufacturer is capable of providing sufficient quantities of our Noden Products to meet anticipated demands. Our foreign long-term supply agreement is subject to, among other risks, FDA approval, governmental clearances, export duties, political instability, and restrictions on the transfers of funds.
Any inability to obtain our Noden Products on a timely basis, or any significant price increases not passed on to customers, could have a material adverse effect on our business, results of operations and financial condition.
Distribution
We entered into an arrangement with a third party logistic provider (“3PL”) who has commenced distribution of our Noden Products within the United States on our behalf. Our Noden Products are sold directly to wholesalers from 3PL-owned distribution centers.
The pharmaceutical industry’s largest wholesale distributors, Amerisource Bergen, McKesson and Cardinal Health, accounted for 1.6%, 1.9% and 1.6%, respectively, of our total net sales in fiscal year 2016.
Employees
As of
December 31, 2016
, we had eleven full-time employees managing our intellectual property, our asset acquisitions, operations and other corporate activities as well as providing for certain essential reporting and management functions of a public company. In addition, we have eight full-time employees at our Noden subsidiaries who manage Noden’s business and operations. None of our employees are covered by a collective bargaining agreement.
About PDL
We were incorporated under the laws of the state of Delaware in 1986 under the name Protein Design Labs, Inc. In 2006, we changed our name to PDL BioPharma, Inc. Our business previously included a biotechnology operation that was focused on the discovery and development of novel antibodies. We spun-off the operation to our stockholders as Facet Biotech Corporation in December 2008. Our principal executive offices are located at 932 Southwood Boulevard, Incline Village, Nevada, 89451, (775) 832-8500, and our website address is www.pdl.com. The information in or accessible through our website is not incorporated into, and is not considered part of, this filing.
Available Information
We file electronically with the U.S. Securities and Exchange Commission (the “SEC”) our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that website is www.sec.gov.
We make available free of charge on or through our website at www.pdl.com
our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and proxy statements, as well as amendments to these reports and statements, as soon as practicable after we have electronically filed such material with, or furnished them to, the SEC. You may also obtain copies of these filings free of charge by calling us at (775) 832-8500. Also, our Audit Committee Charter, Compensation Committee Charter, Nominating and Governance Committee Charter, Litigation Committee Charter, Corporate Governance Guidelines and Code of Business Conduct, as well as amendments thereto, are also available free of charge on our website or by calling the number listed above. The information in or accessible through the SEC and our website is not incorporated into, and is not considered part of, this filing.
ITEM 1A. RISK FACTORS
You should carefully consider and evaluate all of the information included and incorporated by reference in this Annual Report, including the risk factors listed below. Any of these risks, as well as other risks and uncertainties, could materially and adversely affect our business, results of operations and financial condition, which in turn could materially and adversely affect the trading price of shares of our common stock. Additional risks not currently known or currently material to us may also harm our business.
We have historically derived a significant portion of our royalty revenues from Genentech and other Queen et al. patent licensees which, in the case of our largest licensee, Genentech, expired in early 2016. Failure to acquire additional sources of revenue, including new product acquisitions and royalty revenue, after expiration of our Queen et al. patents and the related licenses may cause us to have insufficient revenues and positive cash flows to continue operations.
Our revenues to date have consisted almost entirely of royalties from licensees of our Queen et al. patents, which expired in December 2014. Of this revenue from licensees, for example, the Genentech Products accounted for
43%
,
70%
and
71%
of our revenues for the years ended
December 31, 2016
,
2015
and
2014
, respectively. Our license agreement with Genentech expired in the first quarter of 2016, and our other licensees, and efforts to identify and replace those sources of revenues in the future might not be successful. Failure to replace Queen et al. patent license revenues in an amount sufficient to continue our operations would have a material adverse effect on our business.
Our business plan is to continue to acquire additional income generating assets and products. However, we do not expect that these acquisitions will, in the near term, replace the revenues we have generated from our license agreements related to the Queen et al. patents. Specifically, after the first quarter of 2016, our revenues materially decreased after we stopped receiving significant payments from these Queen et al. patents license agreements and related legal settlements, and our continued success will become more dependent on the timing and our ability to acquire new income generating assets and products in order to generate revenues going forward to support our business model. We may be unable to acquire sufficient income generating assets and products for a number of reasons, including the fact that the acquisition of new products, royalty revenues or other income generating assets in the healthcare industry is a highly competitive area in which other companies, financial institutions and private funds compete for assets of interest to us. Those entities may have access to lower costs of capital, strategic opportunities or competitive advantages that may not be available to us. Other factors that may prevent us from acquiring favorable income generating assets and products include the following:
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•
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we may be unable to acquire income generating assets and products on terms that would allow us to make an appropriate level of return from the asset;
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•
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our products and asset investments may be less successful in the marketplace than may be necessary to generate an appropriate level of return from the asset; or
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•
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we may be forced to undertake more risk in obtaining the assets we pursue.
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If we are unable to acquire suitable income generating assets and products in the near term, our business may suffer and we may determine that a wind-down, sale, or liquidation of the Company is in the best interests of our stockholders.
Any difficulties from strategic acquisitions could adversely affect our stock price and results of operations.
We may acquire companies, businesses and products that complement or augment our existing business. We may not be able to integrate any acquired business successfully or operate any acquired business profitably. Integrating any newly acquired business could be expensive and time-consuming. Integration efforts often take a significant amount of time, place a significant strain on managerial, operational and financial resources and could prove to be more difficult or expensive than we predict. The diversion of our management’s attention and any delay or difficulties encountered in connection with any future acquisitions we may consummate could result in the disruption of our ongoing business or inconsistencies in standards and controls that could negatively affect our ability to maintain third party relationships. Moreover, we may need to raise additional funds through public or private debt or equity financing, or issue additional shares, to acquire any businesses or products, which may result in dilution for stockholders or the incurrence of indebtedness.
Our investment in Noden is our first investment in support of commercial products rather than an investment in financial assets or royalties for income generation. Our returns from the investment in Noden are dependent upon the success of the acquired prescription pharmaceutical product sold under the brand names Tekturna, Tekturna HCT, Rasilez and Rasilez HCT and there can be no assurance that we will be able to successfully attain and maintain significant market acceptance of our products among physicians, patients, third party payors and others in the health care community.
We are dependent upon Noden and its management team in gaining and maintaining acceptance among physicians, third party payors, patients and others in the health care community for our products. Continued market acceptance of any approved product depends on a number of other factors, including:
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•
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the clinical indications for which the product is approved and the labeling required by regulatory authorities for use with the product, including any warnings that may be required in the labeling;
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•
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acceptance by physicians and patients of the product as a safe and effective treatment;
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•
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the cost, safety, efficacy and convenience of treatment in relation to alternative treatments;
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•
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the restrictions on the use of our products together with other medications;
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•
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the manufacture of good manufacturing practices compliant active pharmaceutical ingredient (“API”) and finished product in sufficient quantities and in a timely manner;
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•
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the availability of adequate coverage and reimbursement or pricing by third party payors and government authorities; and
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•
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the effectiveness of sales and marketing efforts.
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Noden has limited commercial experience and is undertaking the commercialization of the Noden Products with a new contract sales force in the United States and no current commercial infrastructure outside the United States. Our revenues from the investment in Noden depend on Noden’s ability to successfully transition the Noden Products to a new commercial team, the failure of which could have an adverse impact on our revenues and the value of our investment in Noden.
In addition, the supply agreement with Novartis commits Noden to minimum purchase obligation of the Noden Products, which may result in excess inventory if Noden’s new commercial team is not able to sell the Noden Products at sufficient levels to cover the minimum purchase obligations. If we experience excess inventory, it may be necessary to write down or even write off such excess inventory, which could adversely affect our operating results.
Through our investment in Noden, we have a significant investment in the commercialization of products worldwide, and our returns on investment on the Noden Products are subject to a number of risks associated with international operations that could materially and adversely affect our business.
As a result of our acquisition of the Noden Products through our investment in Noden, we expect to be subject to a number of risks related to the sale of products worldwide, including:
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•
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international regulatory requirements for drug marketing and pricing in foreign countries;
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•
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varied standards of care in various countries that could complicate the commercial success of products;
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•
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varied drug import and export rules;
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•
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varying standards for the protection of intellectual property rights which may result in reduced or compromised exclusivity in certain countries;
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•
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unexpected changes in tariffs, trade barriers and regulatory requirements;
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•
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varied reimbursement systems and different competitive drugs indicated to treat the indications for which Noden Products are being commercialized;
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•
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economic weakness, including inflation, or political instability in particular foreign economies and markets;
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•
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compliance with tax, employment, immigration and labor laws applicable to foreign operations;
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•
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compliance with the U.S. Foreign Corrupt Practices Act (“FCPA”), the UK Bribery Act, and other anti-corruption and anti-bribery laws;
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•
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foreign taxes and duties;
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•
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foreign currency fluctuations and other obligations incident to doing business in another country;
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•
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workforce uncertainty in countries where labor unrest is more common than in the United States;
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•
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reliance on management, contract services organizations and other third parties that may be less experienced with manufacturing and commercialization than the party from whom the Noden Products were acquired;
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•
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potential liability resulting from product liability laws or the activities of foreign distributors; and
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•
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business interruptions resulting from geopolitical actions, including war and terrorism, or natural disasters.
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In addition, our international operations could be affected by currency fluctuations, capital and exchange controls, expropriation and other restrictive government actions as well as by political unrest, unstable governments and legal systems and inter-governmental disputes. Any of these circumstances could adversely affect our business.
Product sales are expected to generate a significant share of our revenues in the future and are subject to the risks and uncertainties of branded pharmaceutical products.
If our products become subject to problems such as changes in prescription growth rates, product liability litigation, unexpected side effects, regulatory proceedings, manufacturing issues, publicity affecting doctor or patient confidence, pressure from existing competitive products, changes in labeling, loss of patent protection (when applicable), or, if a new, more effective treatment should be introduced, the adverse impact on our revenues could be significant.
We depend upon a limited number of wholesalers for a significant portion of our revenues from the Noden Products, and the loss of, or significant reduction in sales to, any one of these wholesalers could adversely affect our operations and financial condition.
We sell the Noden Products primarily to wholesalers. Wholesalers sell the Noden Products to hospitals and physician offices. We do not promote the Noden Products to wholesalers, and they do not set or determine demand for Noden Products. Our ability to successfully commercialize Noden Products will depend, in part, on the extent to which we are able to provide adequate distribution of the Noden Products to patients. Although we have contracted with a number of wholesalers, they are expected generally to carry a very limited inventory and may be reluctant to be part of our distribution network in the future if demand for the product does not increase.
The use of pharmaceutical wholesalers involves certain risks, including, but not limited to, risks that these pharmaceutical wholesalers will not provide us accurate or timely information regarding their inventories, demand from wholesaler customers buying the Noden Products or complaints about the Noden Products, that these wholesalers will reduce their efforts or discontinue to sell or support or otherwise not effectively sell or support the Noden Products, or not devote the resources necessary to sell the Noden Products in the volumes and within the time frames that we expect.
Further, it is possible that these wholesalers could decide to change their policies or fees, or both, at some time in the future. This could result in their refusal to carry smaller volume products such as Noden Products, or lower margins or the need to find alternative methods of distributing the Noden Products. Although we believe we can find alternative channels to distribute the Noden Products on relatively short notice, our revenue during that period of time may suffer and we may incur additional costs to replace any such wholesaler. The loss of any large wholesaler as part of our distribution network, a significant reduction in sales we make to wholesalers, or any failure to pay for the Noden Products we have shipped to them could materially and adversely affect our results of operations and financial condition.
We have significantly restructured our business and revised our business plan, including entering into a new segment reporting structure. The product sales segment and restructured business plan have been in effect for a limited period of time and there are no assurances that we will be able to successfully implement our business plan or successfully operate in our product sales segment.
We have traditionally focused on acquiring income generating assets when such assets can be acquired on terms that we believe allow us to increase return to our stockholders. Prospectively, we expect to focus on the acquisition of additional products in our product sales segment and expect to transact fewer royalty transactions and still fewer debt transactions. We anticipate that over time more of our revenues will come from our product sales segment and less of our revenues will come from our income generating assets segment. Our strategy is based on a number of factors and assumptions, some of which are not within our control, such as the actions of third parties. There can be no assurance that we will be able to successfully execute all or any elements of our strategy, or that our ability to successfully execute our strategy will be unaffected by external factors. If we are unsuccessful in growing our product sales business as planned, our financial performance could be adversely affected.
Our current and future acquisitions of other material income generating assets and products may not produce anticipated revenues, and if such transactions are secured by collateral, we may be, or may become, under-secured by the collateral or such collateral may lose value and we will not be able recuperate our capital expenditures in the acquisition.
We are engaged in a continual review of opportunities to acquire income generating assets and products, whether royalty-based or otherwise, or to acquire companies who own or are acquiring pharmaceutical products, or that hold royalty or other income generating assets. We currently, and generally at any time, have acquisition opportunities in various stages of active review, including, for example, our engagement of consultants and advisors to analyze particular opportunities, technical, financial and other confidential information, submission of indications of interest and involvement as a bidder in competitive auctions or other processes for the acquisition of income generating assets and products. Many potential acquisition targets do not meet our criteria, and for those that do, we may face significant competition for these acquisitions from other financial investors and enterprises whose cost of capital may be lower than ours. Competition for future asset acquisition opportunities in our markets is competitive and we may be forced to increase the price we pay for such assets or face reduced potential acquisition opportunities. In addition, ten out of seventeen of our acquisitions to date have been or are dependent on, or secured by, a single product revenue stream, which increases the risk of payments based on the competitive factors in the market as well as the pricing of the product. The success of our income generating asset acquisitions is based on our ability to make accurate assumptions regarding the valuation, timing and amount of payments, which is highly complex and uncertain, and the success of our equity investments and product acquisitions is based on our ability to accurately measure the anticipated commercial success, including regulatory approval and pricing, of our products and our counterparties products, which is difficult and subject to various competitive and market factors that may be outside of our control. For example, recently there has been heightened governmental scrutiny over the manner in which drug manufacturers set prices for their commercial products, which has resulted in several Congressional inquiries and proposed bills designed to, among other things, bring more transparency to product pricing, review the relationship between pricing and manufacturer patient programs, and reform government program reimbursement methodologies for drug products. We are unable to control the pricing strategies used by our counterparties, and if our counterparties fail to use appropriate pricing strategies, or receive negative reactions to their pricing strategies, it could negatively impact products from which our revenues would be derived. The failure of any of our acquisitions to produce anticipated revenues may materially and adversely affect our financial condition and results of operations.
Some of these income generating acquisitions expose us to credit risk in the event of default by the counterparty, and we expect the credit-based mix of assets in our portfolio to increase in the future. To mitigate this risk, on occasion, we may obtain a security
interest as collateral in the assets of such counterparty. Our credit risk in respect of such counterparty may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount we are due pursuant to the terms of the particular income generating assets or products. This could occur in circumstances where the original collateral was not sufficient to cover a complete loss (e.g., our interests were only partially secured) or may result from the deterioration in value of the collateral, so that, in either such case, we are unable to recover our full capital outlay and any anticipated return. Additionally, we may face difficulty in collection efforts with respect to a credit agreement counterparty that is in default under a credit agreement with us. Such difficulties could lead to litigation or other legal procedures which may or may not be successful, and which will require significant financial and management resources to address. For example, we have been engaged in multiple legal proceedings with Wellstat Diagnostics and its affiliates related to their credit agreement default, which is described in more detail in Note 22, “Legal Proceedings,” and in Note 22, “Financial Statements and Supplementary Data” of this Annual Report. Any such losses resulting therefrom could materially and adversely affect our financial condition and results of operations.
We and our licensees, borrowers and royalty-agreement counterparties may be unable to maintain regulatory approvals for currently licensed products, or to obtain regulatory approvals or favorable pricing for new products, and we or they may voluntarily remove currently licensed products from marketing and commercial distribution. Any of such events, whether due to safety issues or other factors, could reduce our revenues.
We and our licensees, borrowers and royalty-agreement counterparties are subject to stringent regulation with respect to product safety and efficacy by various international, federal, state and local authorities. Of particular significance are the FDA requirements covering research and development, testing, manufacturing, quality control, labeling and promotion of drugs for human use in the United States. As a result of these requirements, the length of time, the level of expenditures and the laboratory and clinical information required for approval of a biologic license application or new drug application are substantial and can require a number of years. In addition, even if our products, or our licensees’, borrowers’ and royalty-agreement counterparties’ products receive regulatory approval, we and they will remain subject to ongoing FDA and other international regulations including, but not limited to, obligations to conduct additional clinical trials or other testing, changes to the product label, new or revised regulatory requirements for manufacturing practices, written advisements to physicians and/or a product recall or withdrawal. We and our licensees, borrowers and royalty-agreement counterparties may not maintain necessary regulatory approvals for our or their existing licensed products or we or our licensees may not obtain necessary regulatory approvals on a timely basis, if at all, for any of our products, or the licensed products our licensees are developing or manufacturing. Moreover, the current political environment in the United States is focused on potential reductions in pricing for pharmaceutical and other health care products, which may negatively impact any existing or new products from which our revenues would be derived. We are unable to control the pricing strategies used by our licensees, borrowers and royalty-agreement counterparties, and if they fail to use appropriate pricing strategies, or receive negative reactions to their pricing strategies, it could negatively impact our revenues. In addition, communications from government officials regarding pricing for pharmaceutical and other health care products could have a negative impact on our stock price, even if such communications do not ultimately impact our products or our licensees’, borrowers’ and royalty-agreement counterparties’ products. The occurrence of adverse events reported by any licensee, borrower or royalty-agreement counterparty may result in the revocation of regulatory approvals or decreased sales of the applicable product due to a change in physicians’ willingness to prescribe, or patients’ willingness to use the applicable product.
We and our licensees, borrowers and royalty-agreement counterparties could also choose to voluntarily remove licensed products from marketing and commercial distribution. In any of these cases, our revenues could be materially and adversely affected. For example, in November 2011, the FDA removed the indication for breast cancer from Avastin’s label. In 2005, Tysabri, was temporarily suspended and then returned to the market. In such cases, our revenues could be materially and adversely affected.
In addition, the current regulatory framework could change, or additional regulations could arise at any stage during our licensees’ product development or marketing which may affect our licensees’ ability to obtain or maintain approval of their licensed products. Delays in our licensees receiving regulatory approval for licensed products or their failure to maintain existing regulatory approvals could have a material adverse effect on our business.
Many of our potential income generating assets and products are in companies or assets that have limited commercialized revenue-generating products or are dependent on the actions of unrelated third parties, which may negatively impact our investment returns.
In anticipation of the expiration of our Queen et al. patents and related license agreements, we recently began acquiring, and plan to continue acquiring, pharmaceutical products. Our investment objective with respect to these transactions is to maximize our portfolio’s total return by generating current income from product sales. We consummated our first investment of this type with Noden in July 2016. In addition, we have made and will likely continue to make investments in income generating assets and
products, such as equity investments in product focused companies, loans in exchange for a profit share or royalty streams, in the healthcare industries, which investments may be in companies that, at the time of investment, have limited or no commercialized revenue-generating products. If the assets are not successfully commercialized, the value of our investments would be negatively affected and our investment returns would be negatively impacted. The ultimate success of our investments in many of our potential income generating assets and products in these industries will depend on our ability, and the ability of our counterparties or their licensees to innovate, develop and commercialize products, in competitive and highly regulated markets. Our or their inability to do so would negatively affect our investment returns. In addition, in connection with many of our potential income generating assets and products, we are dependent, to a large extent, on third parties to enforce certain rights for our benefit. For example, we acquired certain royalty rights from Depomed, which, as the licensor of certain patents, retains various rights, including the contractual right to audit its licensees and to ensure those licensees are complying with the terms of the underlying license agreements. Depomed also retains full responsibility to protect and maintain the intellectual property rights underlying the licenses. While we have contractual rights to require Depomed to take action regarding many of these rights, because Depomed’s economic interest in the license agreements is limited, it may not enforce or protect those rights as it otherwise would have had it retained the full economic interest in the payments under the license agreements. Moreover, in respect of the royalty stream relating to the Glumetza diabetes medication that we acquired from Depomed, which is the royalty right producing the highest revenues from our Depomed acquired royalties, a single generic manufacturer entered the market in February 2016 and two additional generic manufacturers entered the market in August 2016 as provided for in settlement agreements between Depomed and these generic manufacturers. We were aware of these settlement agreements, considered them in the cost of the acquiring this asset and expect the entry of these generic products to reduce our Glumetza revenues.
We and our licensees, borrowers and royalty-agreement counterparties face significant market pressures with respect to our and their products, and the amount of revenues from our investment in Noden or royalties from our income generating assets and products that we receive are subject to various competitive and market factors that may be outside of our control.
We and our companies, licensees, borrowers and royalty-agreement counterparties face competition from other pharmaceutical, biotechnology, device and diagnostic companies. The introduction of new competitive products may result in lost market share for us or our licensees, borrowers and royalty-agreement counterparties, reduced use of our or their products, lower prices and/or reduced product sales, any of which could reduce our royalty revenues, or the revenues on which we rely to produce the returns on our acquisitions, and have a material adverse effect on our results of operations.
The amount of any royalties and returns on our investments that we receive from our income generating assets and products will depend on many factors, including the following:
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the timing and availability of generic product competition for our products, and our licensees’, borrowers’ and royalty-agreement counterparties’ products;
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potential challenges or design arounds to product, use or manufacturing related patents which provide exclusivity for products and assets before their expiration by generic pharmaceutical manufacturers;
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the size of the market for our products, and our licensees’, borrowers’ and royalty-agreement counterparties’ products;
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the extent and effectiveness of the sales and marketing and distribution support our licensees’, borrowers’ and royalty-agreement counterparties’ products and the implementation of a new sales force and commercial infrastructure with commercial experience in connection with the commercialization of our products;
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the existence of novel or superior products to our products, or our licensees’, borrowers’ and royalty-agreement counterparties’ products;
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the availability of reduced pricing and discounts applicable to our licensees’, borrowers’ and royalty-agreement counterparties’ products;
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stocking and inventory management practices related to our products or our licensees’, borrowers’ and royalty-agreement counterparties’ products;
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limitations on indications for which our products or our licensees’, borrowers’ and royalty-agreement counterparties’ products can be marketed; the competitive landscape for approved products and developing therapies that compete with our products or our licensees’, borrowers’ and royalty-agreement counterparties’ products;
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the ability of patients to be able to afford our products, or our licensees’, borrowers’ and royalty-agreement counterparties’ products or obtain health care coverage that covers those products;
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acceptance of, and ongoing satisfaction with, our products and our licensees’, borrowers’ and royalty-agreement counterparties’ products by the care providers, patients receiving therapy and third party payors; or
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the unfavorable outcome of any potential litigation relating to our products and our licensees’, borrowers’ and royalty-agreement counterparties’ products.
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For example, in 2015, Valeant announced two price increases on Glumetza, a royalty-bearing product under our Depomed Royalty Agreement. The impact of Valeant’s price adjustments on our Depomed royalty entitlement is difficult to predict. While the price increases would be expected to increase revenues and thus our royalties, the entry of one generic manufacturer into this market in February of 2016 and two additional generic manufacturers in August 2016 has resulted in a significant reduction in market share for Glumetza. Due to the uncertainties caused by changes in pricing by third parties that are outside our control and generic competition, we may not be able to accurately estimate the impact on royalties on such sales paid to us for Glumetza or any other product. Additionally, Noden’s ’111 Patent, expires in July of 2018, or up to January of 2019 if extended by virtue of pediatric testing requirements. While Noden has additional patent coverage related to drug formulation and manufacturing technology which relate to our commercialization of Tekturna in the United States and which expires later than 2019, competitors may be able to design around these patents and, as a result, we may face generic competition with respect to Tekturna in the United States earlier than the expiration of these latter patents.
We and our licensees must protect our and their intellectual property rights for us to succeed.
Our success is dependent in significant part on our ability and the ability of third parties in control of the assets in which we’ve invested to protect the scope, validity and enforceability of our and their intellectual property, including the patents, SPCs and license agreements, all of which support our revenues. The scope, validity, enforceability and effective term of patents and SPCs can be highly uncertain and often involve complex legal and factual questions and proceedings. In addition, the legal principles applicable to patents in any given jurisdiction may be altered through changing court precedent and legislative action, and such changes may affect the scope, strength and enforceability of our patent rights or the nature of proceedings which may be brought related to the relevant patent rights. A finding in a proceeding related to patent rights which support our revenues which narrows the scope or which affects the validity or enforceability of some or all of our patent rights could have a material impact on our ability to continue to collect royalty payments from our investments or collect revenue from our income generating assets and product sales.
We rely on third party manufacturers to manufacture our products, and these third parties may not perform adequately.
We do not have any operating manufacturing facilities at this time, and do not expect to independently manufacture our products or any future products. We currently rely on Novartis for a specified period of time to manufacture the Noden Products, and are required thereafter to identify and transition to third parties to scale-up, manufacture and supply the Noden Products. Risks arising from reliance on third party manufacturers include:
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inability to identify and enter into a manufacturing and supply agreement with a third party manufacturer having the appropriate capabilities to cost-effectively and timely manufacture products at the sales levels that we anticipate;
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inability of any third party manufacturer to qualify or maintain qualification to manufacture in accordance with applicable regulatory requirements, including cGMP and ICH requirements;
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reduced control and additional burdens of oversight as a result of using third party manufacturers for all aspects of manufacturing activities, including regulatory compliance and quality control and assurance;
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termination or non-renewal of manufacturing and supply agreements with third parties in a manner or at a time that may negatively impact commercialization activities; and
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disruption in the operations of third party manufacturers or suppliers unrelated to our products, including the bankruptcy of the manufacturer or supplier or a catastrophic event affecting the third manufacturers or suppliers.
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Any of these events could adversely affect our ability to successfully commercialize our products. In addition, if any third party manufacturer terminates its engagement with us or fails to perform as agreed, we may be required to find replacement manufacturers, which would result in significant cost and delay.
In addition, difficulties or delays in product manufacturing and reliance on third party manufacturing could affect our future results reflected in the performance of Noden and the Noden Products by virtue of regulatory actions, shut-downs, approval delays, withdrawals, recalls, penalties, supply disruptions or shortages or force majeure events, reputational harm, product liability, unanticipated costs or otherwise. Examples of such difficulties or delays include, but are not limited to, the inability to increase production capacity commensurate with demand; the possibility that the supply of incoming materials may be delayed or become unavailable or be subject to increased costs and that the quality of incoming materials may be substandard and not detected; the possibility that third party manufacturers may fail to maintain appropriate quality standards throughout the internal and external supply network and/or comply with cGMPs and other applicable regulations such as tracking and tracing of products in the supply chain to enhance patient safety; risks to supply chain continuity as a result of natural or man-made disasters at a
supplier or vendor; or failure to maintain the integrity of the supply chains against intentional and criminal acts such as economic adulteration, product diversion, product theft, and counterfeit goods.
Regulatory agencies periodically inspect drug manufacturing facilities to ensure compliance with applicable cGMP requirements. If our product contract manufacturers cannot successfully manufacture material that conforms to specifications or the regulatory requirements of the FDA or other regulatory authorities, regulatory approval for our products may be jeopardized. In addition, we will have limited or no control over the ability of contract manufacturers to maintain adequate quality control, quality assurance and qualified personnel.
Recently enacted and future legislation is expected to increase the difficulty and costs to maintain revenues from our products, and in particular may negatively impact the pricing of our products.
In the United States and some foreign jurisdictions, there have been, and we expect there will continue to be, a number of legislative and regulatory changes and proposed changes regarding the healthcare system that could, among other things, affect our ability to profitably sell our products.
For example, in the United States in March 2010, the U.S. Patient Protection and Affordable Care Act (the “ACA”) was enacted to increase access to health insurance, reduce or constrain the growth of healthcare spending, enhance remedies against fraud and abuse, add new transparency requirements for health care and the health insurance industries, impose new taxes and fees on the health industry and impose additional health policy reforms. The law has continued the downward pressure on pharmaceutical pricing, especially under the Medicare program, and increased the industry’s regulatory burdens and operating costs. Among the provisions of the ACA of importance are the following:
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an annual, non-tax deductible fee payable by any entity that manufactures or imports specified branded prescription drugs payable to the federal government based on each company’s market share of prior year total sales of branded products to certain federal healthcare programs;
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an increase in the statutory minimum rebates a manufacturer must pay under the Medicaid Drug Rebate Program;
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a new methodology by which rebates owed by manufacturers under the Medicaid Drug Rebate Program are calculated for drugs that are inhaled, infused, instilled, implanted or injected;
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extension of manufacturers’ Medicaid rebate liability to individuals enrolled in Medicaid managed care organizations;
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expansion of eligibility criteria for Medicaid programs in certain states;
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a new Medicare Part D coverage gap discount program, in which manufacturers must agree to offer 50% point-of-sale discounts off negotiated prices of applicable brand drugs to eligible beneficiaries under their coverage gap period, as a condition for the manufacturer’s outpatient drugs to be covered under Medicare Part D;
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expansion of the entities eligible for discounts under the Public Health Service pharmaceutical pricing program;
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a new requirement to annually report drug samples that manufacturers and distributors provide to physicians; and
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a new Patient-Centered Outcomes Research Institute to oversee, identify priorities in, and conduct comparative clinical effectiveness research, along with funding for such research.
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The potential financial impact of the ACA over the next few years will depend on a number of factors including policies reflected in implementing regulations and guidance and changes in sales volumes for products affected by the new system of rebates, discounts and fees. We expect that the new Presidential Administration and U.S. Congress will seek to modify, repeal, or otherwise invalidate all, or certain provisions of, the ACA. In January 2017, Congress voted to adopt a budget resolution for fiscal year 2017 (the “Budget Resolution”), that authorizes the implementation of legislation that would repeal portions of the ACA. The Budget Resolution is not a law; however, it is viewed as the first step toward the passage of legislation that would repeal certain aspects of the ACA. Congress also could consider subsequent legislation to replace elements of the ACA that are repealed. Further, on January 20, 2017, President Trump signed an Executive Order directing federal agencies with authorities and responsibilities under the ACA to waive, defer, grant exemptions from, or delay the implementation of any provision of the ACA that would impose a fiscal or regulatory burden on states, individuals, healthcare providers, health insurers, or manufacturers of pharmaceuticals or medical devices.
In addition, other legislative changes have been proposed and adopted in the United States since the ACA was enacted. These changes included aggregate reductions to Medicare payments to providers of 2% per fiscal year, which went into effect in April 2013 and, due to subsequent legislative amendments to the statute, will remain in effect through 2025 unless additional action is
taken by Congress. In January 2013, the American Taxpayer Relief Act of 2012 was signed into law, which, among other things, further reduced Medicare payments to several types of providers and increased the statute of limitations period in which the government may recover overpayments to providers from three to five years. In addition, recently there has been heightened governmental scrutiny over the manner in which drug manufacturers set prices for their commercial products. The implementation of cost containment measures or other healthcare reforms may limit us from being able to generate revenue, attain profitability, or commercializing our products, which could have a material adverse effect on business and results of operations.
In any event, we expect that additional state and federal healthcare reform measures will be adopted in the future, any of which could limit the amounts that federal and state governments will pay for pharmaceutical products, which could result in reduced demand for our products or our counterparties’ products or additional pricing pressures on our products or our counterparties’ products.
The growth of managed care organizations (“MCOs”) is expected to increase pricing pressures on our products in the United States.
In the United States in particular, the influence of MCOs has increased in recent years due to the growing number of patients receiving coverage through MCOs. The growth of MCOs has increased pressure on drug prices as well as revenues for pharmaceutical companies. One objective of MCOs is to contain and, where possible, reduce healthcare expenditures. MCOs typically use formularies as a means to negotiate prices with pharmaceutical providers; physician protocols requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine; volume purchasing; and long-term contracts. In addition, by placing branded medicines on higher-tier status in their formularies or non-preferred tier status, MCOs transfer a portion of the cost of those medicines to the patient (through and increase in co-payment requirements), resulting in significant out-of-pocket expenses for the patient. This financial disincentive is a means by which MCOs manage drug costs and influence patients to use medicines preferred by the MCOs.
Exclusion of a product from a formulary or other MCO-implemented restrictions can significantly impact drug usage in the MCO patient population. Consequently, pharmaceutical companies compete to gain access to formularies for their products. Unique product features, such as greater efficacy, better patient ease of use, or fewer side effects, are generally beneficial to achieving access to formularies. Larger pharmaceutical companies have the ability to bundle available products and discounts in an effort to place and maintain products on formulary. We will be responsible for meeting the requirements of MCO’s in the United States and ensuring the competitive use of our products in a highly uncertain and changing environment. There can be no assurance that we will be able to maintain or increase the use of our products, and their inability to succeed could have a material adverse impact on the value of our investments.
Generic products may increase pricing pressures on our products.
Although we believe that our products benefit from both issued and/or pending patents as well as proprietary manufacturing technology, one competitive challenge that our branded pharmaceuticals products face is or will be from generic pharmaceutical manufacturers. Upon the expiration or loss of patent protection for a product, especially a small molecule product, the major portion of revenues for that product may be dramatically reduced in a very short period of time. Several such competitors make a regular practice of challenging product patents before their expiration. Also, manufacturers of generic pharmaceutical products may file or have already filed Abbreviated New Drug Applications (“ANDA”) with the FDA seeking to market generic forms of our products prior to the expiration of relevant patents owned by Noden. We are aware of two such ANDAs that have been filed with the FDA with respect to Tekturna, but neither has been approved. Patent litigation and other challenges to Noden’s patents would be costly and unpredictable, would require extensive management time and resources, and may ultimately deprive us of market exclusivity for our products in a given geographical territory. The FDA ANDA approval process exempts generics from costly and time-consuming clinical trials to demonstrate their safety and efficacy, allowing generic manufacturers to rely on the safety and efficacy data of the innovator’s product. Generic competitors do not generally need to conduct clinical trials and can market a competing version of a product after the expiration or loss of patent or regulatory exclusivity and often charge significantly lower prices. In addition, as noted above, MCOs that focus primarily on the immediate cost of medicines often favor generics over branded drugs. Many governments also encourage the use of generics as alternatives to brand-name drugs in their healthcare programs. Additionally, certain foreign governments have indicated that compulsory licenses to patents may be granted in the case of national emergencies or in other circumstances, which could diminish or eliminate sales and profits from those regions and negatively affect our results of operations.
Our products may develop undesirable side effects or have other properties impacting safety or efficacy.
Undesirable side effects caused by our products or similar products sold or developed by other companies, could reveal a high and unacceptable severity and prevalence of side effects or adverse events, a number of potentially significant negative consequences could result, including:
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regulatory authorities may withdraw approvals of such product;
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regulatory authorities may require additional warnings on the label;
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we may be required to create a medication guide outlining the risks of such side effects for distribution to patients;
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we could be sued and held liable for harm caused to patients; and
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our reputation may suffer.
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Any of these events could significantly harm our business and the value of our investments.
Our third party contractors as well as our own employees may engage in misconduct or other improper activities, including noncompliance with regulatory standards and requirements, which could result in significant liability for us and harm our reputation.
We are exposed to the risk of fraud or other misconduct in connection with international business operations and our reliance on third party contractors to manage and conduct those activities with respect to our products. These risks include potential failures to:
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comply with FDA regulations or similar regulations of comparable foreign regulatory authorities;
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provide accurate information to the FDA or comparable foreign regulatory authorities;
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comply with manufacturing standards applicable to our products;
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comply with federal and state healthcare fraud and abuse laws and regulations and similar laws and regulations established and enforced by comparable foreign regulatory authorities;
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comply with the FCPA, the UK Bribery Act, and other anti-bribery laws;
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report financial information or data and our business affairs accurately;
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or disclose unauthorized activities to us.
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Our investment in Noden, an Irish entity, subjects us to both United States and international tax laws with respect to the structure and operations of our business and the business conducted by Noden, which are subject to continued scrutiny and change by governments and may result in additional liabilities that may affect our results of operations.
Noden is incorporated in Ireland and maintains the performance of certain functions and ownership of certain assets in a more tax-efficient jurisdiction than the United States. Taxing authorities, such as the United States Internal Revenue Service (“IRS”), actively audit and otherwise challenge these types of arrangements, and have regularly done so in the pharmaceutical industry. We remain subject to reviews and audits by the IRS and other taxing authorities from time to time, and the IRS or other taxing authority may challenge our structure and intra-company arrangements through an audit or lawsuit. Responding to or defending against those and other challenges from taxing authorities could be expensive and in any event would consume time and other resources, and divert management’s time and focus from business operations. We generally cannot predict whether taxing authorities will conduct an audit or file a lawsuit challenging our current structure, the cost involved in responding to any inquiry or audit or lawsuit, or the outcome. If we are unsuccessful, we may be required to consolidate income and pay greater taxes as well as interest, fines or penalties, and may be obligated to pay increased taxes in the future, any of which could have a material adverse effect on our results of operations and could negatively affect our ability to be competitive in the acquisition of future, additional products.
Our acquisition of pharmaceutical products, including the Noden Products, will make us subject to more extensive healthcare laws, regulation and enforcement and our failure to comply with those laws could have a material adverse effect on our results of operations and financial condition.
The acquisition of pharmaceutical products, and our sales and marketing efforts with respect to our products, will increase our potential risk of civil and criminal enforcement by the federal government and the states and foreign governments. The laws, regulations and codes that may affect us in the United States include:
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the federal Anti-Kickback Statute, which prohibits, among other things, persons from knowingly and willfully soliciting, receiving, offering or paying remuneration, directly or indirectly, to induce, or in return for, the purchase or
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recommendation of an item or service reimbursable under a federal healthcare program, such as the Medicare and Medicaid programs;
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federal civil and criminal false claims laws and civil monetary penalty laws, which prohibit, among other things, individuals or entities from knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid, or other third party payors that are false or fraudulent;
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The Health Insurance Protability and Accountability Act of 1996 (“HIPAA”), which created new federal criminal statutes that prohibit executing a scheme to defraud any healthcare benefit program and making false statements relating to healthcare matters;
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HIPAA, as amended by the Health Information for Economic and Clinical Health Act of 2009 (“HITECH”), and its implementing regulations, which imposes certain requirements relating to the privacy, security, and transmission of individually identifiable health information;
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the federal physician sunshine requirements under the Patient Protection and Affordable Care Act (“PPACA”), which requires manufacturers of drugs, devices, biologics, and medical supplies to report annually to the Centers for Medicare and Medicaid Services (“CMS”), information related to payments and other transfers of value to physicians, other healthcare providers, and teaching hospitals, and ownership and investment interests held by physicians and other healthcare providers and their immediate family members;
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guidelines promulgated by the Office of Inspector General of the U.S. Department of Health and Human Services related to pharmaceutical company regulatory compliance programs and the PhRMA Code on Interactions with Healthcare Professionals, as amended;
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foreign and state law equivalents of each of the above federal laws, such as the FCPA, anti-kickback and false claims laws that may apply to items or services reimbursed by any third party payor, including commercial insurers;
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state laws that require pharmaceutical companies to comply with the pharmaceutical industry’s voluntary compliance guidelines and the applicable compliance guidance promulgated by the federal government, or otherwise restrict payments that may be made to healthcare providers and other potential referral sources;
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state laws that require drug manufacturers to report information related to payments and other transfers of value to physicians and other healthcare providers or marketing expenditures; and
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state laws governing the privacy and security of health information in certain circumstances, many of which differ from each other in significant ways, thus complicating compliance efforts.
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We do not have experience in establishing the compliance programs necessary to comply with this complex and evolving regulatory environment and our reliance on Noden to operate and address these requirements appropriately increases the risks that we may be found to violate the applicable laws and regulations if they are applied to us. If we are found to be in violation of any of such laws or any other governmental regulations, we may be subject to penalties, including civil and criminal penalties, damages, fines, the curtailment or restructuring of our operations, the exclusion from participation in federal and state healthcare programs and imprisonment, any of which could materially adversely affect interests in our products, including having a material adverse effect on our financial results.
Our common stock may lose value, our common stock could be delisted from NASDAQ and our business may be liquidated due to several factors, including the expiration of our Queen et al. patents, the failure to acquire additional sources of revenue, decrease in revenues from of our income generating assets, the payment of dividends or distributions to our stockholders and failure to meet analyst expectations.
Our revenues to date have consisted mostly of royalties from licensees of our Queen et al. patents, which patents expired in December of 2014 and most related licenses expired in the first quarter of 2016.
Prospectively, we expect to focus on the acquisition of additional products and anticipate that over time more of our revenues will come from our product sales segment and less of our revenues will come from our income generating assets segment. If we are unable to successfully execute all or any elements of our strategy, our financial performance could be adversely affected, and the price of our common stock may fall. If the price of our common stock were to fall and remain below NASDAQ listing standards, our common stock may be delisted. If our common stock were delisted, market liquidity for our common stock could be severely affected and our stockholders’ ability to sell securities in the secondary market could be limited. Delisting from NASDAQ would negatively affect the value of our common stock. Delisting could also have other negative results, including, but not limited to, the potential loss of confidence by employees, the loss of institutional investor interest and fewer business development opportunities.
The lack of liquidity for the assets in our acquisitions may adversely affect our business and, if we need to sell any of our acquired assets, we may not be able to do so at a favorable price. As a result, we may suffer losses.
We generally acquire patents, royalty rights and debt instruments that have limited secondary resale markets. The illiquidity of most of our assets may make it difficult for us to dispose of them at a favorable price and, as a result, we may suffer losses if we are required to dispose of any or all such assets in a liquidation or otherwise. In addition, if we liquidate all or a portion of our assets quickly or in connection with a liquidation, we may realize significantly less than the value at which we had previously recorded these assets.
We may use a certain amount of cash from time to time in order to satisfy the obligations relating to our convertible notes. The maturity or conversion of any of our convertible notes may adversely affect our financial condition and operating results.
As of
December 31, 2016
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$126.4 million
in principal remained outstanding under our 4.0% Convertible Senior Notes due February 1, 2018 (the “February 2018 Notes”), that requires us to repay the full principal amount on February 1, 2018 if not previously converted and $150.0 million in principal amount outstanding under the 2.75% Convertible Senior Notes due December 1, 2021 (the “December 2021 Notes”) that requires us to repay the full principal amount on December 1, 2021 if not previously converted.
Our ability to make scheduled payments of the principal of, to pay interest on, to pay any cash due upon conversion of, or to refinance, our indebtedness, depends on our future performance, which is subject to economic, financial, competitive and other factors beyond our control. Our business may not generate cash flow from operations in the future sufficient to service our debt and make necessary capital expenditures. If we are unable to generate such cash flow, we may be required to adopt one or more alternatives, such as selling assets, restructuring debt or obtaining additional equity capital on terms that may be onerous or highly dilutive. Our ability to refinance our indebtedness will depend on the capital markets and our financial condition at such time. We may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in a default on our debt obligations.
Holders of the February 2018 Notes may convert their notes at their option under the following circumstances at any time prior to the close of business on the business day immediately preceding August 1, 2017: (i) during any fiscal quarter commencing after the fiscal quarter ending June 30, 2014, if the last reported sale price of our common stock for at least 20 trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter exceeds 130% of the conversion price for the notes on the last day of such preceding fiscal quarter; (ii) during the five business-day period immediately after any five consecutive trading-day period, which we refer to as the measurement period, in which the trading price per $1,000 principal amount of notes for each trading day of that measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate for the notes for each such day; or (iii) upon the occurrence of specified corporate events.
Holders of the December 2021 Notes may convert their notes at their option under the following conditions at any time prior to the close of business on the business day immediately preceding June 1, 2021: (i) during any fiscal quarter (and only during such fiscal quarter) commencing after the fiscal quarter ending March 31, 2017, if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive), in the period of 30 consecutive trading days, ending on, and including, the last trading day of the immediately preceding fiscal quarter, exceeds 130% of the conversion price for the notes on each applicable trading day; (ii) during the five business day period immediately after any five consecutive trading-day period (the measurement period), in which the trading price per $1,000 principal amount of the December 2021 Notes for each trading day of that measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate for the notes for each such trading day; or (iii) upon the occurrence of specified corporate events.
Neither the February 2018 Notes nor the December 2021 Notes are currently convertible. The February 2018 Notes are net-share settled and the December 2021 Notes may be settled by paying or delivering, as applicable, cash, shares of our common stock or a combination of cash and shares of our common stock, at our election, although it is the current intention that they will be net-share settled. If one or more holders elect to convert their notes when conversion is permitted, we would be required to make cash payments to satisfy up to the face value of our conversion obligation in respect of each note, which could adversely affect our liquidity.
We may use a certain amount of cash from time to time in order to satisfy repurchase or other obligations relating to our convertible notes which could adversely affect the amount or timing of any distribution to our stockholders or any income
generating transactions. In addition, we may redeem, repurchase or otherwise acquire the convertible notes in the open market in the future, any of which could adversely affect the amount or timing of any cash distribution to our stockholders.
The conversion or any future exchanges of any of the February 2018 Notes or December 2021 Notes into shares of our common stock would have a dilutive effect that could cause our stock price to go down.
Until August 1, 2017, the February 2018 Notes are convertible into shares of our common stock only if specified conditions are met and thereafter convertible at any time, at the option of the holder. Until June 1, 2021, the December 2021 Notes are convertible into shares of our common stock only if specified conditions are met and thereafter convertible at any time, at the option of the holder. We have reserved shares of our authorized common stock for issuance upon conversion of these convertible notes. Upon conversion, the principal amount is due in cash, and to the extent that the conversion value exceeds the principal amount, the difference is due in shares of common stock. If any or all of these convertible notes are converted into shares of our common stock, our existing stockholders will experience immediate dilution of voting rights and our common stock price may decline. Furthermore, the perception that such dilution could occur may cause the market price of our common stock to decline.
We entered into purchased call option and warrant transactions in connection with the issuance of each of our February 2018 Notes that may affect the value of our common stock.
In connection with the issuance of the February 2018 Notes, we entered into purchased call option transactions. Separately, we also entered into warrant transactions at that time. The purchased call option transactions are expected to reduce the potential dilution with respect to our common stock upon conversion of the February 2018 Notes. The warrants in connection with these purchased call option transactions could separately have a dilutive effect from the issuance of our common stock pursuant to the warrants.
The purchased call option and warrant transactions are accounted for as an adjustment to our stockholders’ equity. In connection with hedging these transactions, the counterparties to the hedge transactions or their respective affiliates may enter into, or may unwind, various derivative transactions and/or purchase or sell our common stock in secondary market transactions prior to maturity of the February 2018 Notes (and are likely to do so during any cash settlement averaging period related to any conversion of the February 2018 Notes). Such activities could have the effect of decreasing the trading price of our common stock during any cash settlement averaging period related to a conversion of the February 2018 Notes.
In addition, we intend to exercise the purchased call options whenever February 2018 Notes are converted, if ever. In order to unwind their hedge positions with respect to those exercised options, the hedge counterparties or their respective affiliates may sell shares of our common stock in secondary market transactions or unwind various derivative transactions with respect to our common stock during the cash settlement averaging period for the converted notes. The effect, if any, of any of these transactions and activities on the trading price of our common stock will depend, in part, on market conditions and cannot be ascertained at this time, but any of these activities could adversely affect the value of our common stock.
Further, a failure by the hedge counterparties or their respective affiliates (due to bankruptcy or otherwise) to pay or deliver, as the case may be, amounts owed to us under the purchased call option transactions will not reduce the consideration we are required to deliver to a holder upon its conversion of the February 2018 Notes and may result in an increase in dilution with respect to our common stock.
We entered into a capped call transaction in connection with the issuance of our December 2021 Notes that may affect the value of our common stock and any desired dilution mitigation will be limited to the extent that our stock price rises above the cap price of the capped call transaction.
In connection with the issuance of our December 2021 Notes, we entered into a capped call transaction, with a hedge counterparty, which we expect to reduce the potential dilution upon conversion of the December 2021 Notes in the event that the market price per share of our common stock, as measured under the terms of the capped call transaction, at the time of exercise is greater than the strike price of the capped call transaction, which corresponds to the initial conversion price of the notes and is subject to certain adjustments similar to those contained in the December 2021 Notes. If, however, the market price per share of our common stock, as measured under the terms of the capped call transaction, exceeds the cap price ($4.88 per share) of the capped call transaction, there would nevertheless be dilution to the extent that such market price exceeds the cap price of the capped call transaction.
In connection with hedging the capped call transaction, the hedge counterparty or its affiliates:
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expect to purchase our common stock in the open market and/or enter into various derivatives and/or enter into various derivative transactions with respect to our common stock; and
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may enter into or unwind various derivatives and/or purchase or sell our common stock in secondary market transactions.
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These activities could have the effect of increasing or preventing a decline in the price of our common stock concurrently with or
following the pricing of the December 2021 Notes and could have the effect of decreasing the price of our common stock during the period immediately prior to a conversion of the December 2021 Notes.
The hedge counterparty or its affiliates are likely to modify their hedge positions in relation to the capped call transaction from time to time prior to conversion or maturity of the December 2021 Notes by purchasing and selling our common stock, other of our securities, or other instruments they may wish to use in connection with such hedging.
In addition, we intend to exercise options we hold under the capped call transaction whenever the December 2021 Notes are converted. In order to unwind its hedge positions with respect to those exercised options, the counterparty or affiliates thereof expect to sell our common stock in secondary market transactions or unwind various derivative transactions with respect to our common stock during the period immediately prior to conversion of the December 2021 Notes. We have also agreed to indemnify the hedge counterparty and affiliates thereof for losses incurred in connection with a potential unwinding of their hedge positions under certain circumstances.
The effect, if any, of any of these transactions and activities on the market price of our common stock will depend in part on market conditions and cannot be ascertained at this time, but any of these activities could adversely affect the value of our common stock. For further information regarding the mechanics of our capped call transaction refer to our discussion in the Liquidity and Capital Resources section of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 13, “Convertible Notes and Term Loans” in Item 8, “Financial Statements and Supplementary Data”of this Annual Report.
Despite our current debt levels, we may still incur additional debt; if we incur substantial additional debt, these higher levels of debt may affect our ability to pay the principal of and interest on our convertible notes.
We and our subsidiaries may be able to incur substantial additional debt in the future, some of which may be secured debt. The indenture governing the convertible notes do not restrict our ability to incur additional indebtedness or require us to maintain financial ratios or specified levels of net worth or liquidity. If we incur substantial additional indebtedness in the future, these higher levels of indebtedness may affect our ability to pay the principal of and interest on our convertible notes, or any fundamental change in purchase price or any cash due upon conversion, and our creditworthiness generally.
Changes in the third-party reimbursement environment may affect product sales from which we receive royalty revenues.
Sales of our products and of products from which we receive royalties and our borrowers generate revenues will depend significantly on the extent to which reimbursement for the cost of such products and related treatments will be available to physicians and patients from various levels of United States and international government health authorities, private health insurers and other organizations. Third-party payers and government health administration authorities increasingly attempt to limit and/or regulate the reimbursement of medical products and services, including branded prescription drugs. Changes in government legislation or regulation, such as the ACA; the Health Care and Education Reconciliation Act of 2010; the Medicare Improvements for Patients and Providers Act of 2009 and the Medicare, Medicaid and State Children’s Health Insurance Program Extension Act of 2007 and changes in formulary or compendia listing or changes in private third-party payers’ policies toward reimbursement for such products may reduce reimbursement of the cost of such products to physicians, pharmacies and distributors. Decreases in third-party reimbursement could reduce usage of such products and sales to collaborators, which may have a material adverse effect on our royalties and the revenues of our borrowers. In addition, macroeconomic factors may affect the ability of patients to pay or co-pay for costs or otherwise pay for our products or the products from which we generate royalties and our borrowers generate revenues by, for example, decreasing the number of patients covered by insurance policies or increasing costs associated with such policies.
We have implemented a corporate structure taking into consideration our limited operations and potentially applicable tax impact on our royalty and other income, and any changes in applicable tax laws and regulations or enforcement positions of tax authorities may negatively impact our financial condition and operating results.
We have established our corporate structure to be closely aligned with the financial nature of our business. There can be no assurance that the applicable tax laws and regulations will continue in effect or that the taxing authorities in any or all of the
applicable jurisdictions will not challenge one or more aspects or characterizations of our corporate structure and the treatment of transactions or agreements within our corporate structure, or determine that the manner in which we operate our business is not consistent with our corporate structure. We may also have disputes with one or more state tax authorities regarding whether we are subject to that state’s tax and, if we are subject to such state’s tax, what proportion of our revenues is subject to taxation in such state. For example, we are currently subject to an audit by the California Franchise Tax Board and, while we may disagree with their conclusions regarding such issues, the proceedings extend over long periods of time and we may ultimately be required to pay taxes either in a settlement or a final decision of an agency or court. Any unfavorable changes in laws and regulations or positions by tax authorities could harm our financial position and results of operations.
We may have exposure to additional tax liabilities.
In accordance with U.S. generally accepted accounting principles (“GAAP”), we do not provide for U.S. federal income taxes or tax benefits on the undistributed earnings or losses of our non-U.S. subsidiaries because, for the foreseeable future, we do not have the intention to repatriate those undistributed earnings or losses to the United States. However, our practice of not repatriating undistributed earnings to the United States limits the amount of cash that would otherwise be available to us to pay dividends or repurchase shares of our common stock from the market. In addition, certain activities conducted by our foreign subsidiaries may give rise to United States corporate income tax, even if there are no distributions to the United States. These taxes would be imposed on us when our subsidiaries that are controlled foreign corporations generate income that is subject to Subpart F of the U.S. Internal Revenue Code (“Subpart F”). Passive income, such as rents, royalties, interest and dividends, is among the types of income subject to taxation under Subpart F. Any income taxable under Subpart F is taxable in the United States at federal corporate income tax rates of up to 35.0%. Subpart F income that is taxable to us, even if it is not distributed to us, may also include income from intercompany transactions between our U.S. and non-U.S. subsidiaries, or where our non-U.S. subsidiaries make an “investment in U.S. property,” within the meaning of Subpart F, such as holding the stock in, or making a loan to, a U.S. corporation.
While we may mitigate this increase in its effective tax rate through claiming a foreign tax credit against its U.S. federal income taxes or potentially have foreign or U.S. taxes reduced under applicable income tax treaties, we are subject to various limitations on claiming foreign tax credits or we may lack treaty protections in certain jurisdictions that will potentially limit any reduction of the increased effective tax rate. A higher effective tax rate may also result to the extent that losses are incurred in non-U.S. subsidiaries that do not reduce our U.S. taxable income.
We depend on our licensees and royalty-agreement counterparties for the determination of royalty payments. While we have rights to audit our licensees and royalty-agreement counterparties, the independent auditors may have difficulty determining the correct royalty calculation, we may not be able to detect errors and payment calculations may call for retroactive adjustments. We may have to exercise legal remedies to resolve any disputes resulting from the audit or otherwise related to non-performance by a licensee or royalty counterparty.
The royalty payments we receive are determined by our licensees based on their reported sales. Each licensee’s calculation of the royalty payments is subject to and dependent upon the adequacy and accuracy of its sales and accounting functions, and errors may occur from time to time in the calculations made by a licensee. Our license and royalty agreements provide us the right to audit the calculations and sales data for the associated royalty payments; however, our right to conduct such audits may be limited in terms of the covered periods, and such audits may occur many months following our recognition of the royalty revenue, may require us to adjust our royalty revenues in later periods and may require incurring additional expenses on our part. Further, our licensees and royalty-agreement counterparties may be uncooperative or have insufficient records, which may complicate and delay the audit process.
Although we regularly exercise our royalty audit rights, and reference publicly available information in the assessment of the paid royalties, we rely in the first instance on our licensees and royalty-agreement counterparties to accurately report sales and calculate and pay applicable royalties and, upon exercise of such royalty audit rights, we rely on licensees’ and royalty-agreement counterparties’ cooperation in performing such audits. In the absence of such cooperation, we may be forced to exercise legal remedies to enforce our agreements.
We may experience increases and decreases in our revenues due to fluctuations in foreign currency exchange rates and we may be unsuccessful in our attempts to mitigate this risk.
A material portion of our royalties are calculated based on sales in currencies other than the U.S. dollar. Fluctuations in foreign currency rates, particularly the Euro, relative to the U.S. dollar can significantly affect our revenues and operating results. While foreign currency conversion terms vary by license agreement, generally most agreements require that royalties first be calculated
in the currency of sale and then converted into U.S. dollars using the average daily exchange rates for that currency for a specified period at the end of the calendar quarter. For example, when the U.S. dollar weakens in relation to other currencies, the converted amount is greater than it would have been had the U.S. dollar exchange rates remained unchanged. Our revenues may fluctuate due to changes in foreign currency exchange rates and is subject to foreign currency exchange risk. For example, in a quarter in which we generate $70.0 million in royalty revenues and when approximately $35.0 million
is based on sales in currencies other than the U.S. dollar, if the U.S. dollar strengthens across all currencies by 10.0% during the conversion period for that quarter, when compared to the same amount of local currency royalties for the prior year, U.S. dollar converted royalties will be approximately $3.5 million less in the current quarter than in the prior year.
To compensate for Euro currency fluctuations, we hedge Euro currency exposures with Euro forward and option contracts, to offset the risks associated with these Euro currency exposures. We may suspend the use of these contracts from time to time or we may be unsuccessful in our attempt to hedge our Euro currency risk. We will continue to experience foreign currency related fluctuations in our royalty revenues in certain instances when we do not enter into foreign currency exchange contracts or where it is not possible or cost effective to hedge our foreign currency related exposures. Currency related fluctuations in our royalty revenues will vary based on the currency exchange rates associated with these exposures and changes in those rates, whether we have entered into foreign currency exchange contracts to offset these exposures and other factors. All of these factors could materially impact our results of operations, financial position and cash flows, the timing of which is variable and generally outside of our control.
We must attract, retain and integrate key employees in order to succeed. It may be difficult to recruit, retain and integrate key employees.
To be successful, we must attract, retain and integrate qualified personnel. Our business is intellectual property asset management and acquisition, investing in income generating assets and products and maximizing the value of our patent portfolio and related assets, which requires only a small number of employees. Due to the remote location of our company’s headquarters, it may be difficult for us to recruit and retain qualified personnel. If we are unsuccessful in attracting, retaining and integrating qualified personnel, our business could be impaired.
Our agreements with Facet may not reflect terms that would have resulted from arm’s-length negotiations between unaffiliated third parties.
The agreements associated with the spin-off of Facet Biotech Corporation (“Facet”) in December 2008 (the “Spin-Off”), including the Separation and Distribution Agreement, Tax Sharing and Indemnification Agreement and Cross License Agreement, were negotiated in the context of the Spin-Off while Facet was still part of us and, accordingly, may not reflect more favorable terms that may have resulted from arm’s-length negotiations between unaffiliated third parties.
We may have obligations for which we may not be able to collect under our indemnification rights from Facet.
Under the terms of the Separation and Distribution agreement with Facet, we and Facet agreed to indemnify the other from and after the Spin-Off with respect to certain indebtedness, liabilities and obligations that were retained by our respective companies. These indemnification obligations could be significant. The ability to satisfy these indemnities, if called upon to do so, will depend upon our future financial strength. We cannot assure you that, if Facet has to indemnify us for any substantial obligations, Facet will have the ability to satisfy those obligations. If Facet does not have the ability to satisfy those obligations, we may be required to satisfy those obligations instead. For example, in connection with the Spin-Off, we entered into amendments to the leases for the facilities in Redwood City, California, which formerly served as our corporate headquarters, under which Facet was added as a co-tenant under the leases and a Co-Tenancy Agreement under which Facet agreed to indemnify us for all matters related to the leases attributable to the period after the Spin-Off date. Should Facet default under its lease obligations, we would be held liable by the landlord as a co-tenant and, thus, we have in substance guaranteed the payments under the lease agreements for the Redwood City facilities, the disposition of which could have a material adverse effect on the amount or timing of any distribution to our stockholders. As of
December 31, 2016
, the total lease payments for the duration of the guarantee, which runs through December 2021, are approximately $56.4 million. We would also be responsible for lease-related payments including utilities, property taxes and common area maintenance that may be as much as the actual lease payments. In April 2010, Abbott Laboratories acquired Facet and renamed the company Abbott Biotherapeutics Corp., and in January 2013, Abbott Biotherapeutics Corp. was renamed AbbVie Biotherapeutics, Inc. and spun off from Abbott as a subsidiary of AbbVie Inc. We do not know how Abbott’s acquisition of Facet will impact our ability to collect under our indemnification rights or whether Facet’s ability to satisfy its obligations will change. In addition, we have limited information rights under the Co-Tenancy Agreement. As a result, we are unable to determine definitively whether Facet continues to occupy the space and
whether it has subleased the space to another party or the basis upon which our potential co-tenant obligation may be triggered. See “Item 2—Properties.”
As we continue to develop our business, our mix of assets and sources of income may require that we register with the SEC as an “investment company” in accordance with the Investment Company Act of 1940.
We are not registered and have no intention to register as an “investment company” under the Investment Company Act of 1940 (the “40 Act”). As a result, we are not and do not expect to become subject to regulation under the 40 Act, including its reporting and corporate governance requirements and restrictions on leverage and affiliate transactions.
Generally, to avoid being regulated as an “investment company” under the 40 Act an issuer must:
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not be engaged or hold itself out as being engaged primarily in the business of investing, reinvesting or trading in securities and not own or propose to acquire “investment securities” with a value of more than 40% of the value of its total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis; or
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be able to rely on an exception from the definition of “investment company” under the ’40 Act or an exemptive rule.
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“Investment securities” are any securities other than U.S. government securities and securities issued by a majority-owned subsidiary that is not itself either an “investment company” or a private investment company, meaning a company that is excluded from the definition of “investment company” by Section 3(c)(1) or Section 3(c)(7) of the 40 Act.
We have in the past and may in the future rely on one or more exceptions to the definition of “investment company” under the 40 Act, including the exception under Section 3(c)(5) of the 40 Act. To rely on Section 3(c)(5), as interpreted by the staff of the SEC, we would be required to have at least 55% of our total assets in certain qualifying assets. In a no-action letter issued to Royalty Pharma on August 13, 2010, the SEC staff stated that certain royalty interests of the type we own can be treated as qualifying assets.
In light of the change in the composition of our assets as a result of the Noden Transaction, we determined that the exception provided by Section 3(c)(5) might no longer be applicable and we therefore have elected for now to rely on the exemption provided by Rule 3a-2 under the 40 Act for so-called “transient investment companies”. Rule 3a-2 provides a safe harbor for a period of one year so long as the company does not intend to engage primarily in the business of investing, reinvesting, owning, holding or trading in securities and has a bona fide intent to be engaged primarily as soon as is reasonably possible, and in any event within that one-year period, in a non-investment company business. A company may rely on Rule 3a-2 only once during any three-year period.
Our board of directors has determined and resolved that we not engage in the business of investing, reinvesting, owning, holding or trading in securities and is implementing a plan to restructure our business and the composition of our assets to make clear that we are not an “investment company” within the meaning of the 40 Act. This may limit our ability to make certain investments (including divesting certain assets), or require us to take or forego certain actions, that could materially and adversely affect our financial condition and results of operation. There can be no assurance that we will be able to execute that plan within the one-year deadline. In addition, if the SEC, its staff or the courts changes their interpretation of certain provisions of the 40 Act, including Section 3(c)(5), we may need to take additional steps in order to avoid becoming subject to regulation under the 40 Act, which could materially and adversely affect our financial condition and results of operation.
If we were required to register as an “investment company,” the obligations imposed on us by the 40 Act would likely require substantial changes in the way we do business and would result in significant additional regulatory and administrative burdens and costs. In order to remain outside the scope of regulation under the 40 Act, we may need to take various actions which we might otherwise not pursue. These actions may include restructuring our company and modifying our mixture of assets and income, including divesting certain desirable assets immediately, and could have a material and adverse effect on us.
We have in the past and are currently involved in, and expect that in the future we will from time to time be involved in, litigation, either as a defendant or a plaintiff, which could have a negative impact on our operations and results.
Monitoring and defending against or prosecuting legal actions is time-consuming for our management and may detract from our ability to fully focus our internal resources on our core business goal of acquiring and managing income generating assets. In addition, legal fees and costs incurred in connection with such activities may be significant. Depending on the nature of the lawsuit, a decision adverse to our interests could result in the payment of substantial damages and could have a material adverse effect on our cash flow, results of operations and financial position or impact our rights in an adverse way.
Failure in our information technology and storage systems could significantly disrupt the operation of our business.
Our ability to execute our business plan depends, in part, on the continued and uninterrupted performance of our information technology (“IT”) systems. IT systems are vulnerable to damage from a variety of sources, including telecommunications or network failures, malicious human acts and natural disasters. Moreover, despite network security and back-up measures, some of our servers may be vulnerable to physical or electronic break-ins, computer viruses and similar disruptive problems. Despite the precautionary measures we have taken to prevent unanticipated problems that could affect our IT systems, sustained or repeated system failures that interrupt our ability to generate and maintain data could adversely affect our ability to operate our business.
If we fail to maintain an effective system of internal control over financial reporting in the future, we may not be able to accurately report our financial condition, results of operations or cash flows, which may adversely affect investor confidence in us and, as a result, the value of our common stock.
The Sarbanes-Oxley Act requires, among other things, that we maintain effective internal controls for financial reporting and disclosure controls and procedures. We are required, under Section 404 of the Sarbanes-Oxley Act (“Section 404”), to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting. This assessment must include disclosure of any material weaknesses identified by our management in our internal control over financial reporting. A material weakness is a control deficiency, or combination of control deficiencies, in internal control over financial reporting that results in more than a reasonable possibility that a material misstatement of annual or interim financial statements will not be prevented or detected on a timely basis. Section 404 also generally requires an attestation from our independent registered public accounting firm on the effectiveness of our internal control over financial reporting.
Our compliance with Section 404 requires that we incur substantial accounting expense and expend significant management efforts. Noden has limited experience complying with Section 404 and if in the future we identify one or more material weaknesses in our internal control over financial reporting, we will be unable to assert that our internal control over financial reporting is effective. Furthermore, we cannot assure you that there will not be material weaknesses or significant deficiencies in our internal control over financial reporting in the future. Any failure to maintain internal control over financial reporting could severely inhibit our ability to accurately report our financial condition, results of operations or cash flows. If our independent registered public accounting firm determines we have a material weakness or significant deficiency in our internal control over financial reporting, we could lose investor confidence in the accuracy and completeness of our financial reports, the market price of our common stock could decline, and we could be subject to sanctions or investigations by NASDAQ, the SEC or other regulatory authorities. Failure to remedy any material weakness in our internal control over financial reporting, or to implement or maintain other effective control systems required of public companies, could also restrict our future access to the capital markets.
